Fresh Data Give Fed Wiggle Room on Rates at July Meeting

Officials at the Federal Reserve have been speaking out in favor of a three-quarter point interest rate increase at their meeting later this month, while leaving open the possibility of a larger move if economic data came in especially strong. Fresh economic figures released Friday could give them reason to move in either direction.

Most notably, a closely watched measure of longer-term inflation expectations moderated. That should give central bankers confidence that high prices are not becoming so embedded in the American psyche that they become a self-fulfilling prophesy as people ask for higher pay and change their spending patterns.

The data could be critical in keeping officials on course for a three quarter-point rate increase — stocks jumped on the news, suggesting that investors saw it as a sign that the Fed will not make a big rate move this month, which had spooked the markets.

Krishna Guha, an analyst at Evercore ISI, wrote in a note following Friday’s data that the inflation expectations figure likely “gets the Fed out of” a full-point increase.

At the same time, retail sales came in unexpectedly strong, suggesting that demand is chugging along even as the Fed works to restrain it with higher interest rates. That could provide grounds for a full-point rate increase. “Today’s strong report keeps the Fed in an aggressive policy tightening mode,” Kathy Bostjancic, the chief U.S. economist at Oxford Economics, wrote after the release.

Those two new readings on the economy come on the heels of a higher-than-expected June Consumer Price Index reading, one that pushed inflation to a new four-decade high and showed signs that price increases are broadening to rent and services that could take time to cool back down.

Several Fed officials have said in the wake of that report that they would still favor a three-quarter point increase at the central bank’s July 26-27 meeting, but that they would watch incoming consumer spending and inflation expectations data to determine whether a larger move was necessary. Because the data showed that consumption remains solid but inflation expectations are becoming less worrying, they are likely to leave the central bank’s options open.

Still, both data points get revised, making it difficult to take a definitive signal from either. The University of Michigan inflation expectations number for July, which declined to 2.8 percent in preliminary data from a previous reading of 3.1 percent, will be followed up July 29 by a final number for the month that could be different.

Most officials have been signaling that a three-quarter point increase is still their preference, while avoiding taking a full-point move entirely off the table. Markets now see a full-point increase as possible, but not likely.

Central bankers have been hesitant to embrace a bigger rate move than the three-quarter point increase they made last month, which was already the largest since 1994. Raphael Bostic, the president of the Federal Reserve Bank of Atlanta, said on Friday morning at an event in Florida that he would not want to move rates “too dramatically.”