(Reuters) – Contrary to how many Federal Reserve officials have tended to focus on longer-run inflation expectations data as a tool to divine real world price pressures, a Cleveland Fed report released on Monday said shorter-run expectations may be the more important factor to watch right now.
In the present environment “the relationship between current inflation and short-term inflation expectations is much stronger than the relationship between current inflation and longer-term inflation expectations,” Ina Hajdini, an economist at the Cleveland Fed, wrote in a commentary posted on the regional Fed bank’s website.
She said the annualized trend rate of inflation was 3.3% between the start of 2021 and the end of 2022, but hit 3.4% in the fourth quarter of last year, well above the Fed’s 2% target. Short-term inflation expectations readings are above the fourth-quarter reading, and “these data imply that heightened short-term inflation expectations – above trend inflation – can feed into higher inflation, and this channel has become even stronger recently.”
That could put the U.S. central bank in a tough spot as the end of its interest rate hiking campaign comes into sight. Over the last year the Fed has boosted rates aggressively to help quell some of the highest inflation pressures seen in decades.
While policymakers still view inflation as too high, they nevertheless see evidence that the worst of the problem might be over, and reckon that as the economy moves forward, inflation pressures should ease further. New York Fed President John Williams said last week that he sees inflation, now at 5% based on the Fed’s preferred gauge, hitting 3.75% by the end of this year and 2% sometime in 2025.
Fed officials, at their most recent policy meeting, penciled in one more rate increase before a shift to holding rates steady for the remainder of the year.
Part of the Fed’s confidence that inflation will moderate revolves around the relative stability of longer-term inflation expectations data throughout the current episode. While those measures have been above 2%, they’ve also been more stable than shorter-run expectations. At his news conference after the end of the March 21-22 policy meeting, Fed Chair Jerome Powell said longer-run expectations were “well-anchored” across a broad array of measures, be they surveys or market prices.
Fed officials, as well as many private-sector economists, believe that where the public projects inflation will be in the future exerts a strong influence on where it is now. So the focus on longer-term expectations has given officials confidence they will eventually prevail in getting inflation back to target.
NEAR-TERM EXPECTATIONS QUICKEN
The Cleveland Fed report suggests that narrative may need revision. And what’s more, some of the most recent inflation expectations data showed jumps in near-term price pressure expectations. On Friday the University of Michigan consumer sentiment index for March revealed that year-ahead expected inflation was 4.6% in April, a full percentage higher than in March, while New York Fed data for March also showed higher year-ahead expected inflation. Both releases had largely steady longer-run inflation projections.
Meanwhile, additional New York Fed data, also released on Monday, showed that the wages people will accept for a job, as well as the wages they are being offered, are also on the rise, which could in turn increase inflation risks. The regional Fed bank said the average full-time wage offered in the past four months has increased to $62,088 from $59,834 in November 2022, while the lowest wage a worker would accept to take a job hit a record high of $75,811 in March.
For Fed policy, the heightened importance of short-term inflation expectations “implies that there might be added benefits to responding aggressively to current inflation so that trend inflation cools more substantially,” Hajdini wrote. “In that case, even if inflation expectations remain elevated for some time in the near future, they will not be contributing as much as they are now to current inflation because the link between the two would weaken.”
Source: Economy - investing.com
