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. Last Updated: 07/27/2016

Cheap Oil Reduces Inflation

WASHINGTON -- Plunging oil prices are relieving one inflation headache for U.S. central bankers Ben Bernanke and Jean-Claude Trichet, only to give them another.

The same lower energy bills that are removing a source of inflation are also stoking the world economy at a time when it is already growing briskly. That may be enough to force interest rates higher in Europe, and keep them from coming down in the United States.

"It's a special challenge," said Laurence Meyer, a former Federal Reserve governor who is now the Washington-based vice chairman of Macroeconomic Advisers. "Lower inflation might tell you to ease, higher growth might tell you to tighten. What do you do?"

For Federal Reserve Chairman Bernanke and his fellow policymakers in Washington, the answer for now is "nothing at all." The Federal Open Market Committee, meeting Tuesday and Wednesday, is expected to leave its overnight interest rate target at 5.25 percent, where it has stood since June.

Futures trading shows investors see only a 4 percent chance of a rate cut in the first half of this year, down from 72 percent one month ago. Investors have been reducing their bets as evidence accumulates that the U.S. economy is rebounding on the strength of an improving housing market, higher wages and less expensive gasoline. Consumer confidence reached a three-year high in January, according to the Reuters/University of Michigan's monthly index.

Some economists say cheaper energy has no disadvantages from the viewpoint of central bankers. "The Fed's thrilled about falling oil prices," said Mickey Levy, chief economist at Bank of America. Lower energy costs, while giving consumers more spending power, also reduce operating costs for businesses, he says. "The decline in oil prices, a positive supply shock, raises productive capacity as well as aggregate demand."