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July Fed update: Is Fed too focused on past econ conditions to raise bank rates?

| MoneyRates.com Senior Financial Analyst, CFA
min read

There is a feeling of deja vu about reading the statements the Federal Open Market Committee makes after its meetings, including for the latest July meeting. It's more than a feeling as the Fed really has been here before, and it is beginning to seem their focus is more on where the economy has been than on where it is going.

Once again, the Fed announced that it would leave short-term interest rates unchanged, in the ultra-low range of 0.25 to 0.50 percent. The Fed acknowledged improving employment conditions, but expressed concern that inflation was too low - once again. In other words, the statement released following today's Fed meeting was much the same as virtually all of the statements it has issued in the past two years. The concern is that the Fed may be thinking too much about past economic conditions and not enough about how they are changing.

Trends indicate shift in inflation

The Fed uses low interest rates to try to stimulate the economy. Where the concern about low inflation comes in is that it can be a symptom of a weak economy. If the patient exhibits the symptom of low inflation, the Fed prescribes low interest rates.

The problem is that inflation can turn very suddenly, and backward looking measures of inflation can provide a misleading picture. For example, over the past 12 months the rate of inflation is a mild 1.0 percent. However, in the second quarter of this year inflation rose at a rate that would project to inflation of over 3.0 percent.

Another example of how inflationary conditions can change suddenly is seen in energy prices. A 9.4 percent decline in energy prices over the past year played a big role in helping overall inflation stay near zero. However, with energy prices on the rise in recent months, that decline is not likely to be repeated, and may even be reversed to some degree. Remove the advantage of falling energy prices and the inflation picture could become very different.

The inflation rate over the past 12 months indicates to the Fed that continued doses of low interest rates seem appropriate. In actuality though, more recent trends suggest that inflation may already be on the road to recovery.

Bad news for savings accounts and other deposits customers

Savings account rates, money market rates and certificate of deposit (CD) rates are all heavily influenced by the Fed's rate policy. Having to deal with low bank rates ever since the Great Recession has been bad enough for depositors, but at least inflation has been low for most of that time. However, if inflation is accelerating while the Fed is standing pat, depositors will see the purchasing power of their savings erode more quickly.

Given the persistent low interest rate environment of recent years, the view in the rear-view mirror is not very pretty for depositors. If inflation gets ahead of Fed rate policies, the view ahead may be even uglier.

Comment: Do you think the Fed is issuing the same statements for recent meetings?

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