Inflation report likely to conclude the Fed rate hike issue by 0.75 basis points in July

Another big Consumer price increase The Federal Reserve is keeping last month on track to raise the benchmark interest rate by 0.75 percentage points at its meeting later this month.

The Fed raised the interest rate for June, the largest since 1994, raising the benchmark interest rate to a range between 1.5% and 1.75%. Several Federal Reserve officials had already indicated that they were ready Support for another increase of 0.75 points At the July 26-27 meeting to quickly raise interest rates to levels high enough to slow the economy, Wednesday’s report adds to that urgency.

Fed leaders have indicated in recent weeks that the central bank is likely to discuss an increase of either 0.50 percentage point or 0.75 point at its meeting in two weeks. But investors in the interest rate futures markets raised their expectations on Wednesday that prices could rise by a full percentage point at the meeting. Market odds rose by one percentage point to about 38% in the hour following the inflation report, up from 12% before it was released, according to CME Group.

The interest rate outlook is volatile in part because the central bank made an abrupt turnaround in June. Most central bank officials provided specific guidance that the Fed would raise interest rates by half a percentage point at its June meeting before the previous quiet period. But the CPI report released days before the meeting prompted the Fed to raise the interest rate by 0.75 points.

This experience added to the debate among economists on Wednesday over whether the Federal Reserve included the possibility of surprises in the data such as the latest hot inflation report in its latest guidance for its July meeting.

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The Fed is worried about consumers future inflation forecasts It helps explain why more attention is paid to a measure of inflation that includes volatile food and energy prices because it raises interest rates so aggressively.

Usually, the Fed prefers to look at fluctuations in the food and energy categories and focus instead on measures of so-called core inflation, which remove those volatile items. Core CPI rose 5.9% in June from a year earlier. Core inflation tends to predict future inflation more reliably.

Officials are currently placing less weight on the core readings due to concerns that inflation is becoming more unpredictable in general. They are also particularly concerned that the psychology of inflation could shift in a way that will cause consumers and businesses to continue to accept higher prices. Central bankers and economists, having studied closely 1970s experienceworry that these expectations could self-fulfill, drive inflation in general or “headline” to stay high.

“Headline inflation is what people experience,” Fed Chairman Jerome Powell said

He said at a press conference last month. “They don’t know what the substance is. Why are they? They have no reason to. So expectations are very much at risk due to high headline inflation.”

The Federal Reserve uses a different metric, the Commerce Department’s PCE Price Index, as its preferred inflation measure. The CPI tracks the out-of-pocket costs of consumers while the PCE index more closely tracks the total expenditure of households. The Fed is targeting an inflation rate of 2%.

Differences in the construction of the two indicators usually cause the CPI to run slightly above the PCE. But the gap between the two is currently approaching the widest since 1981. This partly reflects rising energy and housing costs, which make up a larger share of the CPI basket.

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According to the PCE index, Consumer prices rose 6.3%. In May of the previous year. Core PCE prices rose 4.7% in May from a year earlier, down from a peak of 5.3% for the twelve months ending in February. Core PCE inflation slowed to a 4% annual rate during the February-May period, the lowest four-month rate since March 2021.

But Powell said the central bank needs to see relief on a larger scale. “Honestly, this is not the time for hyper-accurate inflation readings,” he said. May interview. “We need to see inflation come down in a convincing way…. We won’t assume we have it until we see it.”

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Central banks around the world are in a rush to raise interest rates amid mounting price pressures. Rising fuel costs and supply chain disruptions from Russia’s war against Ukraine have driven up prices in recent months. In the US, increases like this add to inflation that was already high with last year’s high demand from reopening the economy and strong government stimulus.

Monetary policy books say that central banks should not react to supply shocks if they expect an increase or decrease in the price of a commodity, such as oil, to fade over time. Doing so may exacerbate the economic damage from the price shock, as the European Central Bank discovered when it raised interest rates in 2008 and 2011 due to higher oil prices.

With inflation soaring in the United States, rising food and energy costs have pushed the country’s most popular price index to a four-decade high. WSJ’s Gwynn Guilford explains how the CPI works and what it can tell you about inflation. Illustration: Jacob Reynolds

Undoubtedly, if gasoline prices remain at elevated levels but do not rise further, this will eventually translate into lower annual inflation. “What we’re really trying to do is just get it. [commodity prices] to stop going up. If it stabilizes… the inflationary effects disappear. “We don’t want them to actually back off,” Fed Governor Christopher Waller said last week.

At their meeting last month, Fed economists expected PCE inflation to rise to 5% in December before declining to 2.4% at the end of next year as energy prices fall.

However, Fed officials recently said they cannot gradually raise interest rates due to concerns that a combination of shocks could lead to a higher inflation environment. “There’s a clock working here,” said Mr. Powell at the clock. Central Banks Forum in Portugal Last month. “Our job is to literally prevent this from happening, and we will prevent that from happening.”

High inflation “calls into question the traditional view that monetary policy should always consider supply shocks,” Cleveland Fed President Loretta Meester said at the same conference last month. “In some circumstances, such shocks can threaten the stability of inflation expectations and will require policy action.”

Some economists worry that Powell’s focus on core inflation will cause the central bank to raise interest rates too much, causing needless economic weakness. This is partly because even if inflation expectations rise, these economists do not believe that workers will be able to bargain for higher salaries.

Another concern is that near-term inflation expectations tend to rise and fall with gasoline and food prices, but monetary policy cannot easily influence the prices of those items without causing a recession.

Powell acknowledged the point at a congressional hearing last month when a lawmaker asked whether higher gasoline prices would ensure a strong Fed response, but he again cited concerns about higher inflation expectations.

“While these things are out of our control, gas prices and food prices are mostly – and that adds a little bit of urgency in our desire to put our prices where we address inflation head on,” he said. .

write to Nick Timiraos at [email protected]

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