In World Economy News 07/01/2016
The transitory shock to U.S. inflation stemming from lower oil prices and the lofty greenback threatens to be anything but, according to Goldman Sachs.
Senior Economist Zach Pandl indicated that Goldman’s call for a pickup in headline and core inflation this year could be jeopardized by the longevity of these trends—and the Federal Reserve’s preferred tightening trajectory could be as well.
“Under a risk scenario in which the dollar rises another 10 percent and oil prices decline another 25 percent, our models suggest core inflation would end the year at 1.3 percent instead of 1.6 percent,” he wrote, noting that these developments were not a part of Goldman’s base case scenario. “Standard policy rules suggest that the Fed would respond to a shock of this size by skipping 1-2 rate hikes through end-2017, under an assumption that labor markets continued to recover.”
The minutes from the central bank’s December meeting, at which rates were hiked for the first time in nearly a decade, showed monetary policymakers are chiefly concerned about the outlook for inflation.
Members of the Federal Open Market Committee noted that U.S. dollar appreciation could continue to delay the central bank’s quest to see inflation trend higher.
The crude-driven headwind on inflation, meanwhile, was thought to be close to dissipating for two reasons: The decline in oil prices triggers a decline in energy’s share of the indexes used to measure inflation, and the presumption that energy prices would stabilize—or at least stop falling so briskly. With oil prices eclipsing lows not seen since December 2003, the case for smaller positive base effects on headline inflation in the coming readings has gained strength.
“The further decline in oil prices and appreciation in the broad dollar have raised new doubts about a rebound in inflation this year,” acknowledged the economist. “So far Fed officials have mostly looked through the effects of weak commodity prices and the dollar on inflation, arguing that the impact will ultimately prove transitory, even if the period of low inflation has now dragged on for some time.”
