Economist sees Fed hiking rates despite current deflationary trend

Deflationary forces currently coursing through in the U.S. economy will not stop the Federal Reserve from raising interest rates around mid-2015 to head off imbalances in the second half of the year that could sow the seeds for future inflation, according to a noted economist.

Don Ratajczak, emeritus professor of Georgia State University's J. Mack Robinson School of Business and a consulting economist, told the SMC3 annual winter meeting in Atlanta yesterday that the Fed will increase its benchmark federal funds rate in an effort to prevent inflation taking root once growth resumes in earnest starting in the third quarter after a first-quarter lull. The Fed wants to be poised to fight the next war, not gearing up to fight the last one, Ratajczak told the group.

Fed funds, the rate at which banks lend money to each other, usually on an overnight basis, has remained between 0.00 and 0.25 percent since December 2008, during the depths of the financial crisis. It has been widely speculated the Fed will lift the key borrowing rate sometime around mid-year to keep the economic recovery from fueling inflation down the road.

For now, however, deflation is the watchword in the U.S. economy. Monthly consumer price data from October thru December has been negative, and Ratajczak expects more of the same in January. Consumer prices are expected to rise a mere 1.1 percent in 2015, and while wages remain stubbornly stagnant—a scenario Ratajzack admitted he didn't expect at a point in the U.S. economic expansion where when job growth has surged—tepid price increases have left the average U.S. worker with 1.9 percent more purchasing power than a year ago, he said.

Falling oil prices and a surging U.S. dollar continue to suppress inflation, and continued low interest rates make it an excellent time to borrow to invest in plants and equipment, Ratajczak said. U.S. production remains strong and shipping activity is poised to have a solid year, Ratajczak said. However, U.S. factories will face tougher competition from foreign rivals as the strong dollar makes those currencies more price-competitive in U.S. commerce, he added.

Ratajczak expects first-quarter gross domestic product (GDP) growth to come in at 2.5 percent as low energy prices curb spending, investment, and growth across the oil and gas patch. Energy firms have scaled back, postponed, or cancelled planned projects, and many have begun layoffs. Those cutbacks are felt almost immediately, while the benefits of low oil prices on consumer spending and nonenergy business investment take longer to filter through the system. Ratajczak expects full-year GDP growth of between 3.5 and 4 percent, a scenario that will prompt the Fed to act on interest rates.

The economist said oil prices should begin to stabilize sometime next month. However, he wouldn't venture an estimate on oil's trough price. He projects that the price of a barrel of West Texas Intermediate crude oil will end the year at about $70, levels that will lead to an increase in consumer prices.

As of yesterday, oil prices were pegged at $46.39 a barrel, according to data from the Energy Information Administration (EIA). That is a decline of nearly $48 a barrel from the same period in 2014, EIA data show.