Rising commodity prices are an indicator of strengthening demand around the globe. BIS central bankers’ speeches  3    Higher energy prices likely to boost overall inflation in the near term. Whether energy and commodity prices raise inflationary levels for the medium term depends on the persistence of the commodity price rises.   Because commodity price changes have shown less persistence over the last 20 or more years, economists have seen little evidence of pass-through of higher commodity prices into underlying inflation (Chart 39). In the past, sustained rising prices for energy and commodities have been tempered over time by business and household adopting more energy-efficient practices, as well as investment in and adoption of substitute sources. Sixth, what does the market expect the Federal Reserve to do in the near-term? The last statement of the Federal Open Market Committee said:   The Committee…continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.   Current market expectations, inferred from the federal funds (overnight interest rate) futures curve, are that:      The Fed will purchase the full $ billion of Treasury securities by mid 2011.   The Fed will begin to raise the federal funds rate in the second half of 2011 (Chart 41). The Committee has stressed that policy is conditional on the performance of the economy.
The Federal Reserve responded to the slowing of the recovery in midyear 2010 by beginning a second round of large-scale asset purchase programs. Those purchases are resulting in a rough tripling of the Federal Reserve’s balance sheet (Chart 42).   U.S. economic conditions are currently quite far away from levels consistent with the Federal Reserve’s dual mandate of the pursuit of the highest level of employment consistent with price stability. I’ve discussed the high unemployment and unused productive capacity in the United States. Let’s turn to inflation.   While trend inflation is quite low at the moment, we see it likely to be near the low point of this cycle. The rate of inflation for nonenergy services is beginning to increase, led by faster increases in apartment rents (Chart 36). A firming of demand along with a decline of the exchange value of the dollar should begin to put upward pressure on nonfood, nonenergy goods prices.   However, underlying inflation fundamentals suggest relatively low trend inflation for some time:      A substantial amount of slack in the economy, reflected in the sharp deceleration of core services prices – and the United States is a services economy (Chart 35).   Relatively wide profit margins, so that firms facing very competitive output markets are able to absorb changes in energy and commodity prices. Moreover, unit labor costs are still falling (Chart 37).   Inflation expectations remain well anchored (Chart 38).