Memo to Yellen: Fed Getting Desired Inflation Ahead of Forecast

Is the Market Anticipating a More Dovish Fed?
  • Core consumer-spending price index jumps by most since 2012
  • Central bankers seeing `actual' inflation pickup they wanted

Federal Reserve Chair Janet Yellen and her colleagues are getting exactly what they wished for. Just way faster than they, and most economists, expected this year. 

The prices of goods and services consumers buy, excluding food and fuel, rose 0.3 percent in January from December, the biggest gain since 2012, figures from the Commerce Department showed Friday in Washington. That pushed costs up 1.7 percent over the past 12 months, already exceeding the 1.6 percent Fed officials forecast for the fourth quarter of 2016.

The central bank’s goal is to get total inflation up to 2 percent, a level consistent with a healthy economy because anything less threatens to mire the U.S. in the type of too-low price pressures that have hobbled countries like Japan for decades. The jump in prices makes it more likely that members of the policy-making Federal Open Market Committee, who next meet in March, will continue to raise interest rates. The trick, though, will be to time those increases in a way that keeps economic growth humming while preventing prices from overshooting their goal.

“Overall, the committee is going to see this as good news and will be less worried about inflation being too low,” said Roberto Perli, a former Fed official who’s now a partner at Cornerstone Macro LLC in Washington. “It is closer to the sweet spot. This is consistent with a gradual policy path. It gives them room to raise rates, but again very slowly. I don’t think it puts March in play.” Perli expects the next rate increase in June.  

Prior to Friday’s data, investors had assigned very low odds to the prospect of any rate increase this year even as Fed officials had penciled in an additional one percentage point in hikes through 2016. 

Those expectations shifted higher amid the inflation news Friday, with traders’ odds rising above 50 percent for at least one rate rise by the December meeting, according to Bloomberg calculations of interest-rate probabilitiesfrom federal funds futures. Chances for an increase at the June meeting climbed to 35 percent on Friday from 24 percent on Thursday.

Even including food and fuel, which is the measure preferred by Fed officials, prices over the past 12 months climbed 1.3 percent compared with a 0.7 percent increase at the end of 2015. As oil prices stabilize, the gauge is likely to keep marching toward 2 percent.

Policy makers have demonstrated more caution around the price side of their dual mandate as the labor market shows further improvement. In December, they said they were reasonably confident inflation would rise to 2 percent over the medium term, while suggesting that future interest-rate increases would depend on “actual” gains in inflation.

With that goal becoming more within reach, holding off from raising interest rates may become a more delicate proposition to explain to the public.

The jump in prices “is going to make the Fed’s job a lot more difficult, particularly given that they shifted their emphasis from the job market to actual improvements in inflation,” said Ryan Sweet, a senior economist at Moody’s Analytics Inc. in West Chester, Pennsylvania. “They should be more confident that inflation is going to hit their target fairly soon -- late this year or early next. That really makes their communication and their decision in March much more challenging.”

The Commerce Department’s report also showed consumer spending climbed 0.5 percent in January, the most in eight months, indicating higher prices have yet to discourage households from shopping.

Even revised data on fourth-quarter gross domestic product, also out Friday, was influenced by a whiff of higher prices. The world’s largest economy grew at a 1 percent annualized rate from October through December, faster than the 0.7 percent gain reported last month. The reason for the boost: a higher value for inventories.

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