Federal Reserve ponders mystery of weak inflation

WASHINGTON – Federal Reserve officials appeared puzzled at their September meeting about why inflation remains muted given that the nation's unemployment rate is at a 16-year low. But they remain committed to at least signaling the possibility of a third hike in interest rates this year.

The minutes of their discussions released Wednesday show that a group of Fed officials worried that low unemployment could result in a quick rebound in inflation and that a third rate hike was needed. Another group believed that no further increases were called for in the near term.

Economists are split over whether the Fed will raise rates again in December. Some see another rate hike as likely. "[T]he majority of Fed officials are worried that core inflation might not rebound quickly, but that isn't going to stop them from continuing to normalize interest rates, particularly not when the unemployment rate is getting so low," said Paul Ashworth, chief U.S. economist with Capital Economics, in a note.

Others think that if inflation does not start to climb, the Fed will remain on hold.

The Fed has its next meeting Oct. 31-Nov. 1 before a final meeting in mid-December.

Fed Chair Janet Yellen and other Fed officials earlier in the year pointed to transitory factors such as falling prices for mobile cell phone plans as a reason inflation was moving farther from the Fed's 2 percent inflation goal. But with the low inflation persisting, she and other officials have recently acknowledged that perhaps something more long-lasting may be happening.

The minutes of the Fed's September meeting revealed that the mystery over inflation was a key talking point during the two days of discussions.

"Many participants expressed concern that the low inflation readings this year might reflect not only transitory factors but also the influence of developments that could prove more persistent," the minutes said.

"A few of these participants thought that no further increases in the federal funds rate were called for in the near term," the minutes said.

However, another group of Fed officials continued to express worries that inflation could rebound very quickly, given low unemployment. The jobless rate in September fell to 4.2 percent, the lowest since 2001, after having been at 4.4 percent at the time of the Fed's discussions. The sharp one-month decline in unemployment is likely due to the impact of hurricanes Harvey and Irma on the labor market.

The group worried that low unemployment might spark higher wage demands. Rapidly rising inflation pressures could then force the Fed to begin hiking rates more quickly and run the risk of pushing the country into a recession.

This group also worried that the low Fed rates could also result in bubbles in asset prices such as stocks, leading to financial instability.

The Fed's key rate is currently at a still low level of 1 percent to 1.25 percent after two quarter-point rate hikes this year in March and June.