June US inflation data shows the challenge ahead for the Fed. Headline inflation fell 0.2% in June for an annual rate of 3.6%, but the news was the 0.3% m/m rise in the core rate for an annual rate of +1.6%. That result was accompanied by further soft economic indicators, industrial production and consumer confidence.
It’s no wonder then that Ben Bernanke sought to clarify perceptions of further imminent quantitative easing last week. After the release of the June FOMC minutes, the doves had decided that QE3 was just around the corner. That was always going to prove to be wrong.
As we have said before, while the Fed has a dual mandate of full employment and price stability to deliver, we think they will always err on the side of the inflation objective. That’s especially the case when core inflation is rising and they believe recent weakness in the economy will prove to be at least partly transitory.
The most telling Bernanke quote of late was his reference to monetary policy not being a panacea. The Fed can’t fix every problem in the economy.
That doesn’t completely rule out further quantitative easing, but what it does is highlight the fact the Fed will only take action to ease further if they think the weakness in the economy is becoming entrenched to the extent it threatens price stability on the downside.
Our view is the current weakness in the US economy is partly transitory, with growth likely to pick up again later this year. That means the next move for the Fed is a tightening, but continued soft growth will see them not having to act until well into 2012.