FOMC Preview: Inflation Concerns Persist Amid Positive Economic Data

On Monday Federal Reserve Chairman Ben Bernanke spoke at a ceremony marking the central bank's 100 year anniversary. The Federal Reserve System was established on December 23, 1913, when President Woodrow Wilson signed the Federal Reserve Act into law.

On Wednesday the Fed will be back in the spotlight with the highly anticipated FOMC policy announcement and updated economic projections due at 2 p.m. EST. Chairman Bernanke will hold his final quarterly press conference at 2:30 p.m. EST.

In a close decision, the Fed refrained from tapering their $85 billion-a-month bond buying program in September, amid disappointing data on employment growth and uncertaintly over the health of the U.S. economy.

Brighter Economic Data

An improving employment situation has been foremost among a series of recent positive economic data supporting the possibility of a near term taper.

Earlier this month, the U.S. Bureau of Labor Statistics reported that payrolls increased by 203,000 in November, beating analyst expectations of 180,000.

The U.S. November unemployment rate fell to 7 percent, its lowest level in five years, beating analyst expectations of 7.2 percent.

Speaking with Bloomberg TV in late November, James Bullard, president of the Federal Reserve Bank of St. Louis, said, "A strong jobs report, I think, would increase the probability some for a December taper."

Another notably positive report was November Retail Sales. The Commerce Department reported last week that Retail Sales rose a seasonally adjusted 0.7% in November from October, posting the biggest gain since June. Retail sales is a primary indicator of consumer spending, which makes up about two-thirds of total gross domestic product (GDP).

Inflation Concerns

Despite the better employment situation, a below-target inflation rate and the expiration of jobless benefits are factors weighing against a reduction of stimulus at the December meeting. The federal-sponsored Emergency Unemployment Compensation program is on track to expire at the end of the year.

Inflation, as measured by the PCE Price Index, averaged an annual rate of 1.2% in the third quarter, falling substantially short of the Fed target of 2 percent.

At a news conference in September, Bernanke stated, "The Committee would be unlikely to increase rates if inflation were projected to remain below our 2 percent objective for some time."

In discussing the possibility of a taper Fed President James Bullard told CNBC television, "For me, you don't have to be in a hurry because of low inflation."

The result of today's 8:30 a.m. EST Consumer Price Index (CPI) report will play an important role in the Fed's policy decision to be announced on Wednesday.

Unemployment Threshold

The Fed has stated that it won’t raise interest rates until after the unemployment rate reaches a 'threshold' of 6.5 percent or lower.

The forward guidance for the federal funds rate target was outlined at the FOMC’s October 2013 meeting, "the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent."

Additionally, Fed policymakers have asserted that reaching 6.5 percent would not necessarily bring about immediate interest rate increases.