The Federal Reserve are expected to raise the cost of borrowing by 25 basis points later today. However, will 2018 bring the 2-3 rate hikes expected? Is the US economy ready to absorb the tailwinds that come with raising interest rates?
Inflation in the US remains subdued and is one of the key ingredients missing in the economy. A question which has baffled policymakers has been: just why are we not seeing price acceleration close to the 2% target mark?
The lack of inflation can be partly explained by the decrease in energy costs. However, this may not last long. Oil prices are expected to rise this year, as OPEC curtail supplies.
Core inflation, which excludes fuel and food, is the measure closely watched by Fed members, to correctly analyse domestic price changes. Some argue that given the labour market’s strength inflation should be higher and that’s because of the depressed inflationary data, the Fed should not rush interest rates – as the US economy is not growing fast enough.
Donald Trump’s protectionist proposals as well the reform of the US tax code could cause some stimulation in asset prices. A rise in inflation would be met with a faster acceleration of interest rates from the Federal Reserve.
However, Trump’s policies may hinder the balance sheet, they may help support inflation. While exports may soar higher, imports will take a hit as boarder taxes hinder cheap imports. The lack of competition from imports could send US-made goods and services higher, pushing inflation upwards.
The Federal Reserve have said that they will cut inflation off with higher interest rates if it grows beyond the 2% mark, even if that inflation encourages nominal GDP of 3-4%.
Inflation could be derived from the employment sector; the unemployment rate has halved since its highest point. As the US move towards full employment, inflation could steer inflation higher.
One of the other key missing facets is US wage growth. Employers are failing to increase worker’s salaries, which in turn, has dampening wage push inflation.
The Federal Reserve will likely touch on these topics today, asking as they do so in every statement: Where is the inflation?