Commentary: Why the Fed may need to raise key rate above 5.5%I disagree. First of all, I don't think the overall inflation rate is a growing problem right now, and (more importantly, I acknowledge!) I don't think that the Fed sees it as a growing problem. Why would they, when the growth of just about every ex-oil price index has been stable or falling for several months now?
The case for an increase in the federal funds rate has just been bolstered by a jump in British inflation, which has pushed the pound above $2 for the first time since 1992.
...If the Fed does not raise rates, the dollar will continue its fall against the pound as well as compared with the currencies of many other countries. Already down some 30% versus the pound since 2001, the greenback has also dropped about 15% against the Japanese yen and is down close to 40% against the euro, just to name a few.
While this may be helping economic growth by boosting our exports, it is also adding to inflation by boosting prices of imported goods. In turn, this is providing a cover for domestic firms to raise their selling prices, especially since tight labor markets and slowing productivity are increasing business costs and pressuring margins.
...As we all know, inflation here in the U.S. is well above the Fed's comfort zone of 2%. The Fed maintains that housing's woes will not spread to the rest of the economy, and thus drag it into a recession. If that's the case, then a quarter of a point hike to 5.5% may not be enough to bring our inflation to heel.
Secondly, there's considerable evidence that degree to which exchange rate movements have translated into changes in inflation in the US (the "exchange rate pass-through" rate) has been diminishing. In other words, the falling dollar probably won't make inflation rise in the US like it once might have.
Finally, in case you're curious, here's a picture showing import prices (with and without oil) and the US exchange rate (measured by the Fed's broad trade-weighted index). Feel free to tell whatever story you like about the picture, because I don't see much of a consistent story in it. Yes, there's a little bit of a correlation (particularly during the period 2001-02), but the significant fall in the dollar over the past few years has not led to any noticeable surge in import prices.
The dollar is weakening, and may well weaken further. But I just can't get seriously worried about the prospect of this sparking any significant inflation in the US any time soon.