Fed on Track for December Rate Rise, but Inflation Worries Persist -- 2nd Update

Federal Reserve officials said at their latest meeting they likely would raise short-term interest rates "in the near term" because of a strengthening economy, although several said their support for the move would hinge on whether they see inflation picking up.

With three weeks to go until the Fed's final scheduled gathering of 2017, the minutes of the Fed's last meeting reinforced market expectations that a quarter-percentage-point rate increase is imminent. The market for federal-funds futures contracts, where traders bet on the path of interest rates, suggested a 100% probability of a rate increase at the Dec. 12-13 meeting, according to CME Group.

Yet minutes of the Oct. 31-Nov. 1 meeting, released Wednesday with the usual three-week lag, indicated that officials thought persistently weak inflation could stay below their 2% annual target for longer than many expected, raising questions about the pace of rate increases next year.

The Fed at its last meeting held rates steady, but gave a more favorable assessment of the economy. It last raised rates in June to a range between 1% and 1.25%, the second increase of the year. At their Sept. 19-20 policy meeting, Fed officials penciled in one more quarter-percentage-point rate rise in 2017 and three in 2018.

According to the latest minutes, most Fed officials continued to think that a tightening labor market likely would push up inflation over the medium term. At their gathering three weeks ago, "many participants observed, however, that continued low readings on inflation, which had occurred even as the labor market tightened, might reflect not only transitory factors, but also the influence of developments that could prove more persistent," the minutes said.

After touching the Fed's 2% annual target earlier this year, inflation has been weak for seven consecutive months, according to the Fed's preferred gauge, the Commerce Department's personal-consumption expenditures price index. That index rose 1.6% in September from a year ago, well below the Fed's 2% annual target. Core inflation, which strips out volatile food and energy prices, remained weak at a 1.3% annual rate for the second straight month.

For much of this year, Ms. Yellen and other Fed officials said the shortfall in inflation could be caused by transitory factors, like a drop in pricing for wireless phone plans and subdued growth in health-care prices. But in the weeks since their last meeting, some have questioned how transitory the price weakness may be.

"My colleagues and I are not certain that it is transitory, and we are monitoring inflation very closely," Ms. Yellen said Tuesday at New York University's Stern School of Business.

There is also "some hint" that after many years of low inflation, inflation expectations may be drifting down, and "that would be a very undesirable state of affairs," she said.

Her views were echoed in the latest minutes. Several participants expressed concern that persistently weak inflation "could lead to a decline in longer-term inflation expectations or may have done so already."

Since the latest Fed meeting, most readings on the economy and inflation have been positive. The unemployment rate in October dropped to a 17-year low of 4.1%, while firmer underlying numbers from the Labor Department's consumer-price index should go some way to allaying Fed officials' inflation concerns. When excluding food and energy, prices rose 1.8% from a year earlier in October, the strongest annual gain in core prices since April.

"My sense is that the data are moving in a direction that will lead them on the path" of making decisions one meeting at a time, said Stephen Stanley, chief economist of Amherst Pierpont Securities. "We should pay much more attention to what they're saying," he said of Fed officials.

Some officials have said they see little risk from holding off on another rate increase until inflation picks up again.

Chicago Fed President Charles Evans said last week he has an open mind about whether to vote for another move in December, expressing concern that weak inflation may be more enduring than central bankers now recognize. Mr. Evans is a voter on the Fed's policy committee this year.

"I will be looking for signs that inflation is going to pick up, that inflation expectations have been increasing," he said in London, adding that his decision next month will depend on these and other economic data.

Others have been supportive of a rate increase at the next policy meeting.

San Francisco Fed President John Williams said last week the "possibility of one late this year, and maybe three next year, seems like a good starting point" for getting rates back to a more normal level, with "normal" being a federal-funds rate of about 2.5%.

Officials in early October began shrinking the Fed's more than $4 trillion portfolio of mortgage and Treasury bonds by letting predetermined amounts of maturing assets run off its balance sheet. The move had been anticipated for months and caused no major market reaction.

The minutes showed officials were comfortable with the way the drawdown was progressing, saying that the balance sheet wasn't expected to play an active role in monetary policy.

Reflecting earlier statements that the gradual runoff of assets on the balance sheet would run in the background, officials "generally agreed that the statement following this meeting needed to contain only a brief reference to the program and that subsequent statements might not need to mention the program," the minutes said.

Write to Harriet Torry at harriet.torry@wsj.com

(END) Dow Jones Newswires

November 22, 2017 16:40 ET (21:40 GMT)