Fed Not Ready to Declare Mission Accomplished on Inflation

(Bloomberg) -- The Federal Reserve hit its elusive 2 percent inflation target last month but that doesn't mean policy makers are ready to pronounce mission accomplished.

After spending much of the past six years below target, the central bank's preferred measure of inflation rose to that level in March from 1.7 percent the month before, government data on Monday showed.

“We think it's good news but let's not declare victory yet,” is how Ethan Harris, head of global economics research at Bank of America Merrill Lynch in New York, predicted Fed officials will react to the numbers.

The uptick in inflation won't knock policy makers off their path of gradual increases in interest rates although it will eventually prompt them to pencil in four hikes for this year, instead of the three currently forecast, said Peter Hooper, chief economist for Deutsche Bank Securities in New York.

After raising rates in March, Fed Chairman Jerome Powell and his colleagues are expected to hold policy steady at a two-day meeting starting Tuesday. They won't provide a quarterly update of their projections for the rate path until they get together again in June.

Other data to be released this week probably will buttress the case for higher rates. In particular, economists are looking for payroll growth to recover to 191,000 in April from 103,000 in March while unemployment edges down to 4 percent from 4.1 percent. The jobs numbers will be announced on Friday.

A hardening in expectations for Fed rate rises contrasts with signs that other central banks are taking a lower gear on the road away from easy monetary policy.

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Rising price pressures are encouraging the U.S. central bank to press ahead. The personal consumption expenditures price index excluding food and energy costs rose 1.9 percent in March from a year earlier, up from a 1.6 percent increase in February, the data showed.

A year-on-year acceleration in the core measure had been all but assured as a 0.2 percent monthly decline in March 2017 -- largely due to drop in wireless-service costs -- fell out of the calculation. That's why -- along with expectations that underlying inflation may ease back a bit in coming months -- the Fed is likely to react to Monday's news with restraint.

Policy makers forecast core inflation of 1.9 percent in the fourth quarter of this year and 2.1 percent in the closing three months of both 2019 and 2020, according to the median prediction of officials released in March.

Outgoing New York Fed President William Dudley told CNBC on April 16 the central bank might have to alter its strategy of gradual rate increases “if inflation were to go above 2 percent by an appreciable margin.”

“I'm actually very comfortable going above 2 percent by some amount, 2.2 percent, 2.3 percent,” Atlanta Fed President Raphael Bostic told Bloomberg Television on April 5.

The Fed's willingness to allow inflation to go above its objective is partly predicated on the fact that it's spent nearly all its time below 2 percent since the goal was adopted in 2012.

Julia Coronado, president of Macropolicy Perspectives LLC in New York, described the Fed's approach as a “de facto” move in the direction of price level targeting, in which the central bank makes up for misses of its inflation goal in one direction with offsetting misses in the other.

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“I don't think they change their gradual rate path until we've moved decisively above 2 percent and they're concerned that they're going to pierce 2-1/2,” said Bank of America's Harris.

A lot will depend on what's driving inflation.

Joachim Fels, global economic adviser at Pacific Investment Management Co. in Newport Beach, California, said policy makers won't be too worried if prices are being pushed up by temporary factors, such as a run-up in energy costs or the imposition of tariffs on some imports.

“What would concern them more would be more lasting pressure on inflation from a fiscal expansion that lowers the unemployment rate,” he said.

If inflation does rise above 2 percent on a sustained basis, then the Fed will effectively be missing on both sides of its mandate. Inflation will be above its target while unemployment -- at 4.1 percent and forecast to head lower -- will be below the 4.5 percent level policy makers believe is sustainable in the long-run.

Former Fed Governor Laurence Meyer said that will confront the central bank with “a balancing act” in setting monetary policy in response.

“You can't go so fast that you're going to threaten the expansion but you've got to go fast enough to limit the overshoot of inflation,” said Meyer, who now heads Washington-based Monetary Policy Analytics Inc. “Is that possible? Probably not.”

To contact the reporter on this story: Rich Miller in Washington at rmiller28@bloomberg.net.

To contact the editors responsible for this story: Brendan Murray at brmurray@bloomberg.net, Alister Bull

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