WASHINGTON: With the US economy humming along at its fastest clip in more than a decade, the Federal Reserve should be confident about its ability to weather a global slowdown and start lifting interest rates around the middle of next year.

But then there is inflation.

Interviews with Fed officials and those familiar with its thinking show the mood inside is more somber than the central bank’s reassuring statements and evidence of robust economic health would suggest. The reason is the central bank’s failure to nudge price growth up to its 2 per cent target and, more importantly, signs that investors and consumers are losing faith it can get there any time soon.

Despite undershooting the goal for three years, the Fed has long succeeded in convincing markets that the target was within reach. However, inflation expectations have begun slipping in recent weeks, threatening to amplify downward momentum from plunging energy prices and stuttering global growth.

Barring a turnaround, Fed officials would hesitate to raise interest rates as soon as mid-2015 even as gradually as their forecasts now suggest. On Friday, prices of short-term interest rate futures showed traders pushed back their expectations for a “lift-off” in rates from near zero until October 2015, later than most Fed officials have signalled so far.

“The primary concern at the moment is whether you can get back to 2pc in a way that keeps expectations anchored, and maintains the credibility of the Fed as an institution that can achieve its goal,” said Jeffrey Fuhrer, the Boston Fed’s senior policy advisor.

At first sight, a combination of economic growth of nearly 4pc, falling unemployment and price increases of around 1.6pc looks good. Central bankers worry, though, that inflation, instead of picking up further, could head the other way.

For the Fed, 2pc inflation provides a necessary buffer against deflation, and sufficient leeway to leave crisis era “zero lower bound” on interest rates behind and start using them as the main policy lever again.

“We’re below the Fed’s 2-per cent target now, but what if we get to 1pc? And then 0.5? You need to cut that off,” said former Fed Vice Chairman Alan Blinder, who teaches at Princeton University.One Fed official, who declined to be named, told Reuters policymakers must resist the urge to lift rates at the first opportunity because they might be forced to backtrack if inflation failed to pick up.

Narayana Kocherlakota, who has been a dissenting voice and voted against ending the Fed’s bond buying programme in October, says time is ripe for the Fed to come clean on inflation and act.

“A key for us would be to be communicating effectively and then taking actions to live up to that communication that we are trying to get inflation back to 2pc as rapidly as possible,” the Minneapolis Fed president said last in November.

Published in Dawn December 2nd , 2014