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Fed Sees Job Nearly Done

In the Jan. 31 minutes, the risk of inflation is largely played down.
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Updated from 2:37 p.m. EST

The outlook for core inflation is relatively stable after 19 months of interest rate tightening, although energy prices and the economy's appetite for raw materials still pose a "subdued" threat, Fed policymakers said at their Jan. 31 meeting.

"Most participants expected core inflation to move up slightly in the near term, reflecting some pass-through of increased energy and other commodity prices," read minutes to the meeting, Alan Greenspan's last as chairman. "Although heightened inflation pressures could also arise from possible increases in resource utilization, the outlook for economic growth and the stability of inflation expectations suggested that core inflation should remain contained over time."

The Fed raised its official fed funds lever by a quarter-point to 4.5% at the conclusion of the meeting, saying in an accompanying policy statement that "some further policy firming" could be needed to combat rising resource utilization or elevated energy prices. Financial markets viewed the language as a pledge for one and probably two more quarter-point hikes over the next two meetings.

Indeed, some Fed members held that "the possibility of additional policy moves was reinforced by readings on core inflation and inflation expectations that were somewhat higher than was desirable over the long run," the minutes said. The result was a statement that emphasized the importance of future economic data in forming interest rate policy.

Stock and bond prices had little reaction to the minutes' release. Heading into the close, the


was down about 39 points, while the 10-year Treasury yield held firm at 4.56%.

Tuesday's minutes showed that the Fed believes inflation, as measured by the core personal consumption index, will be a "touch higher" this year than in 2005, reflecting the pass-through of higher energy costs and import prices. "But, with energy prices leveling out, core inflation was projected to drop back modestly in 2007," the minutes read.

Most members considered the risk of higher prices being passed through to consumers "subdued," even if they do provide the main source of inflation risk.

"Whatever the size of such pass-through effects..., it was thought that they would probably be temporary in nature and likely diminish as energy prices flattened out, as long as inflation expectations did not move higher," the minutes read. "In that regard, participants were encouraged that, despite recent energy price increases, survey measures of inflation expectations had notched down and longer-term inflation compensation in financial markets was little changed.

"Although high profit margins could imply some existing pricing power, they might also provide a cushion to absorb some future cost increases. Indeed, anecdotal reports suggested that the ability of firms to pass through higher input costs generally remained limited. Nevertheless, the increased prices of energy and other commodities and the possibility of a further rise in resource utilization, which some members viewed as nearly full at present, represented continuing risks, potentially adding to inflation pressures," the minutes said.