Tuesday, November 20, 2007

Fed Forecasts and Inflation

This afternoon, the Federal Reserve will begin the Ben Bernanke new-era economic forecast that will provide Fed updates four times a year, instead of just twice a year. They believe this will help investors better understand the Fed’s economic point of view through greater transparency. In other words, the central bank will forecast early and often.

The accompanying table shows that throughout the first three quarters of 2007, the Fed’s forecasts have actually been quite good, believe it or not. If anything, real GDP growth so far has come in a little better than predicted, with core inflation a bit lower than expected. Think Goldilocks.

A new wrinkle, however, will be the Fed’s forecast of headline inflation that includes food and energy prices. This is very important because it reflects a change in Fed thinking that will emphasize total inflation, rather than only core inflation which excludes food and energy.

Because of high oil prices, I believe the Fed is not likely to lower its target rate at the December 11 meeting. The headline inflation in the fourth quarter will probably come in about 3 percent ahead of last year, comparing unfavorably with the Fed’s 2 percent inflation target.

Keeping the fed funds rate on hold at 4.5 percent also will provide some much-needed support for the sagging dollar.