What Inflation Figures Don't Say about QE3

With consumer prices unchanged, there's one more reason to think the Fed might print more money

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Some economists say prices for everyday items have been growing far faster than government figures indicate

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By any number of measures, the job market is weak. And all you have to do is look at today's Labor Department report that the consumer price index remained unchanged from June to July—and grew by just 1.4 percent over last year—for confirmation that the economy overall just can't claw its way out of a slump.

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So, clearly, there is plenty of room for more Fed stimulus, right?

Not so fast. While recent low inflation readouts (including today's) have prompted speculation of more Fed action like clockwork, it might not be enough to spur the Fed into action.

"I think the Fed certainly takes into account incoming economic data, but when it comes to inflation it's not any one result but kind of a two- to five-year outlook," says Guy LeBas, chief fixed income strategist at financial services firm Janney Montgomery Scott. "Inflation is one of those things that occurs over a long time frame."

The Fed aims for medium-term inflation to be at or below 2 percent, as well as for maximum employment ... and the nation is not there on either count. Unemployment is stuck above 8 percent, and inflation as measured by the Commerce Department's personal consumption expenditures index—the measure that the Fed takes into consideration—was at 1.5 percent in June, and at 1.8 for the "core" price index, excluding volatile food and energy prices.

That inflation rate has slowed in recent months, but the figure doesn't really say much about where prices will go for the rest of the year. That information comes from a look at much broader trends.

While inflation can either act as a constraint or can set the stage for the Fed to boost the economy, says James Marple, senior economist at TD Economics, "they're likely more to be looking at broader economic activity, the weakness in the global economy and in the labor market."

For example, Americans' spending has generally been flat in recent months. That contributes to both a slow economy and stagnant prices.

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"We're in a period in which because there is poor demand in general, there's actually a slowing ability of companies to increase prices," says LeBas. "Today's CPI number reflects the fact that economic demand is very slow."

In other words, if members of the Federal Open Market Committee foresee long-term, low consumer demand—which they very well might, considering the fact that the economy has deep holes to climb out of in both jobs and housing—that might give them more information about future inflation than what recent CPI reports can say.

Then again, the Fed may want to be careful in its moves, with food inflation looming as a result of the current, massive drought.

"The risk is in six to nine months, when the big run-up in agricultural prices we just saw in the commodities market start to hit at the grocery store ... we could be in a situation where the Fed's doing another round of easing at the same time that people are coming home from the grocery store going, 'Oh, man, that box of cereal costs a lot more than it did last year,'" says John Canally, investment strategist at investment firm LPL Financial.

As with today's inflation figures, QE3 speculation seems to be an automatic reaction to nearly every economic report. At the end of July, weak GDP led to chatter that stimulus might be on the way. Earlier this week, when retail sales figures came in higher than expected, experts questioned whether more easing was such a sure bet.

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For now, there is still plenty of expectation for more action. Canally says that it's a question of "when, but not if" the Fed will undertake QE3. LeBas believes that more bond purchases are likely to be announced at the Fed's October or December meetings. While the Fed can announce the new program at any time if it wants to, many are also looking to Federal Reserve Chair Ben Bernanke's speech in Jackson Hole on August 31 or the Federal Open Market Committee's September meeting as potential occasions for the announcement.