Despite Falling Oil Prices, Fed Expected to Raise Interest Rates Midyear

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Janet Yellen by Kosuke Okahara, Bloomberg News

Economists are slashing U.S. inflation forecasts for 2015 as oil prices tumble. What’s not changing are predictions that the Federal Reserve will raise its benchmark interest rate anyway, probably around midyear.

“We’re still saying June with risks to September,” said Michael Gapen, the New York-based chief U.S. economist for Barclays PLC. The Fed “can push rates higher in the middle of the year, even though visually that may look awkward if headline inflation is around zero.”

A stronger dollar, slowing global growth and cheaper oil are holding down costs for goods such as televisions and autos. Fed policymakers probably will look past that and see an improving labor market that will force employers to offer higher wages. Those costs soon will push up the price of such things as rent and restaurant meals, no matter what happens overseas, giving the central bank room to raise interest rates that have been stuck near zero for six years.

The personal consumption expenditure (PCE) price index, the Fed’s preferred measure, will be up 0.5% in the second quarter of 2015 from the same time this year, Barclays economists projected Dec. 19. That’s down from a previous forecast of 1.2%. The consumer price index, a separate gauge, is projected to show a small decline in the 12 months through June.



The Fed’s goal is for PCE inflation to climb around 2% a year.

Core prices, which exclude food and fuel, will rise 1.7% over the same period, according to Barclays’ analysis. That compares with a previously estimated 1.9%.

“Low pass-through into core from falling energy prices, and a gradually improving labor market leads to some wage and services inflation” in 2015 that will help assuage concern the United States. is catching a disinflation bug, said Gapen, a former Fed economist.

Too-low inflation hurts debtors by making it harder to pay off loans. Also, the longer central banks undershoot their price targets, the more their ability to deliver stability will be questioned, undermining expectations further and putting more downward pressure on prices.

Fed Chair Janet Yellen and her colleagues probably will face a communications challenge as they pave the way for the central bank’s first interest-rate increase since 2006. Policymakers have said they believe the plunge in fuel prices will prove temporary, which will be more difficult to substantiate as inflation gauges keep sliding six months from now.

Energy “is going to be pushing down headline inflation and may even spill over to some extent to core inflation,” Yellen said in a Dec. 17 news conference after the central bank’s policy meeting. “But at this point, although we indicated we’re monitoring inflation developments carefully, we see these developments as transitory.”

An improving economy and labor market will help “inflation to move gradually back toward its objective,” she said.