Fed rate hike remains uncertain after Harvey, Irma

Two hurricanes slammed into the United States within two weeks, taking a bite out of economic growth, and adding to doubts about the potential for a third interest rate hike this year.

The Federal Reserve is widely expected to leave interest rates untouched after the two-day policy meeting this week, but economists are split on whether the impact of Hurricanes Harvey and Irma will create enough uncertainty to delay the next tightening move until 2018.

After inflation at long last posted a sizeable uptick in August, markets saw an increased probability of a move in December that would push rates up a notch from the current range of 1.0-1.25 percent.

But Satyam Panday, senior economist at Standard & Poor’s, told AFP this one-off pop in the Consumer Price Index should not obscure the larger reality.

“We don’t expect any rate hike in September or December,” he said. “The underlying trend of inflation still is well below the inflation target of two percent.”

Consumer prices in play?
CPI rose 0.4 percent last month, and the index for the latest 12 months accelerated to 1.9 percent.

As a result, market odds for a December hike jumped, with futures markets showing the probability above 54 percent on Friday, up from 31 percent the week before.

But the August increase in consumer prices was in large part driven by volatile energy prices. Excluding food and energy, 12-month core CPI held steady at 1.7 percent, the same increase seen every month since May.

Fed policymakers have for months downplayed stubbornly low inflation as the result of temporary factors, but core CPI has not risen above 2.3 percent in six years.

And the Fed’s preferred inflation measure, the Personal Consumption Expenditures price index, has been steady at 1.4 percent, while the core measure has been below the central bank’s two percent target for more than five years.

Meanwhile, the Fed is expected this week to announce the start of a plan to reduce the multi-trillion dollar investment holdings built up to support the economy in the wake of the 2008 financial crisis.

While the Fed has said the process will be very gradual, to avoid upsetting financial markets, it will act as a slight tightening of monetary policy akin to an interest rate hike.

Hurricane impact temporary
The double-whammy of Irma and Harvey could shave as much as 0.5 percent off of US GDP in the third quarter, as businesses are disrupted, energy prices rise and hiring weakens.

But economists and Fed officials say the storms will not affect the underlying trend in growth, which has been steady at around two percent in recent years, and activity should rebound later in the year due to reconstruction efforts.

Mark Zandi, chief economist at Moody’s Analytics, said central bankers will “look through the economic impacts of Harvey and Irma, because they know they’re temporary.”

Economist Tim Duy agreed.

“I think that they will still on average lean toward hiking in December,” he told AFP, noting there are a “sufficient number” of officials who believe low inflation is due to temporary factors.

In a speech early this month, influential New York Fed President William Dudley said while he was surprised that inflation had been so low, steady growth of the economy should eventually push wages higher, allowing the Fed to continue to raise rates “gradually.”

Zandi said with the unemployment rate “falling dramatically” and nearing four percent, inflation eventually will follow.

“It’s just a matter of time.”

Along with the policy statement Wednesday, Fed members will release their forecasts for the economy and the course of interest rates, which could give a clearer picture of the sentiment in the central bank.

And by December the Fed may have a more dovish makeup, given that Vice Chair Stanley Fischer, a proponent of tightening, plans to step down next month.

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