A US inflation survey closely watched by the Federal Reserve showed consumer expectations of future price growth eased in July, tempering fears the central bank will raise interest rates by a full percentage point this month.
The University of Michigan’s consumer sentiment study showed households’ expectations of where inflation will be in five years dropped more than expected to 2.8 per cent from the previous reading of 3.1 per cent. The expectation for inflation one year from now was 0.1 percentage point lower at 5.2 per cent.
The preliminary results, which also showed consumer sentiment still near all-time lows, come days after an inflation report that top Fed officials characterised as “uniformly bad” and “major league disappointment”.
Price gains across most goods and services accelerated again in June, according to the consumer price index released by the Bureau of Labor Statistics, with annual inflation hitting a 40-year high of 9.1 per cent.
With core inflation — which strips out volatile items such as food and energy — also picking up in June, traders ratcheted up bets the Fed would jettison its previous policy guidance and implement a full percentage point adjustment at its meeting this month.
At one point, the odds surged to well over half, according to CME Group. That dropped sharply after the Michigan survey showed a moderation of inflation expectations and various Fed officials pushed back on the move.
Just days after saying “everything is in play”, Raphael Bostic, president of the Fed’s Atlanta branch, on Friday said the central bank’s next step should be “orderly”, and that “moving too dramatically” could undermine the economic recovery.
James Bullard of the St Louis Fed on Friday also emphasised that the difference between a 0.75 percentage point move and a larger option might not make too significant a difference in the central bank’s fight against soaring prices.
Instead, he said the benchmark policy rate may need to rise to between 3.75 per cent and 4 per cent by the year-end in order to sufficiently restrain the economy. It currently hovers between 1.50 per cent and 1.75 per cent.
Notably, no official took the larger option off the table entirely — arguing that the final decision would depend on incoming data — but the drop in inflation expectations seals the deal for many economists.
While US retail sales in June came in slightly stronger than expected, advancing 1 per cent, the reading was not robust enough to tip the balance towards a larger rate rise.
The foremost fear motivating the Fed to remain ultra-hawkish in its approach to tightening monetary policy revolves around expectations of future inflation and whether forecasts signal that consumers and businesses think the US central bank has lost control.
The risk is that expectations move higher, further fanning price pressures and unleashing a worrisome cycle that might force the Fed to take even more forceful action in response.
That is a chain reaction the central bank said it could not entertain, with a sharp recession in that scenario all but guaranteed.
So far, market measures of inflation expectations over five and 10 years do not show signs of becoming unmoored. Break-even rates were little changed on Friday, at 2.54 per cent and 2.34 per cent, respectively. Both rates have fallen significantly from peaks in April, as investors have bet that the Fed’s aggressive policy to rein in prices will be effective.
Officials still maintain that the Fed can bring down inflation without causing excessive economic pain, but many have acknowledged the path to that outcome is becoming more narrow and largely depends on external factors such as commodity prices continuing to moderate and supply chain bottlenecks easing.
Wall Street economists are less optimistic, with most pencilling in a recession next year.
Additional reporting by Kate Duguid in New York
Source: Economy - ft.com
