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The wrinkle in Bernanke's plan

September 21, 2012

| MoneyRates.com Senior Financial Analyst, CFA

It's likely that few people were happy to see last Friday's Consumer Price Index (CPI) report, but no one should have been more miserable about it than Ben Bernanke.

Inflation may be the most direct threat to the Federal Reserve's quantitative easing program, and last Friday's report signals that inflation could be coming back with a vengeance.

Oil fuels a possible inflation revival

The Bureau of Labor Statistics reported that the CPI rose by 0.6 percent in August. That's the highest single-month inflation number in more than three years, and a rate of inflation that would project to more than 7 percent over the course of a year.

To temper that a little bit, it should be noted that monthly inflation numbers are subject to some pretty severe swings. There is no reason to believe that inflation will continue to rise at a 7 percent annual rate in the months to come. Still, this flare-up of inflation is especially troubling because it was fueled primarily by gasoline prices, which rose by 9 percent in a single month. This is not only a steep increase in its own right, but one that could creep into the prices of many other things that require oil and gas in their production and transportation.

It was a bad month for inflation, but that's not to say a new trend has taken hold. Due to low inflation in prior months, year-over-year inflation through August was just 1.7 percent. More recently, oil prices have begun to fall, which could take the pressure off inflation.

Somewhere, though, one senses Ben Bernanke's fingers are firmly crossed.

Not good for QE3

Why Bernanke in particular? Just the day before the inflation report, the Federal Reserve announced that it was expanding its monetary stimulus program with a third round of quantitative easing. In making the announcement, the Fed noted that a quiet inflation environment allowed for such a move.

Now, it seems, inflation may not be so quiet. Inflation would not only destroy the stimulative impact of QE3 by discouraging lenders from making loans at low rates, but it might also force the Fed to reverse course and raise interest rates to head off inflation.

A saver's perspective

If Ben Bernanke was unhappy to see inflation rear its ugly head, depositors in savings accounts, money market accounts and other bank products should give him company in his misery. Yes, it could be argued that higher inflation would force higher interest rates, but that would be an empty victory because at best, higher prices would negate the improvement in rates. More likely, savings and money market rates would be slow to catch up with inflation, leaving depositors trailing badly behind.

Thus, you might find yourself joining Bernanke in spirit by anxiously awaiting the next inflation report, which will come out in the middle of October. If inflation is here to stay, it would add an ugly new wrinkle to an already troubled economy.

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