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The Inflation Update: February 2005 Waltham
, It is now official.
In yesterday’s statement accompanying the announced 25 basis point
increase in the federal funds rate target, the FOMC said: “Pressures
on inflation have picked up in recent months and pricing power is more
evident.” Within 20 minutes of
the 2:15pm (EST) release of the Fed’s decision, the yield 10-year U.S.
Treasury note rose from 4.41% to 4.63%. This morning’s BLS release adds
to the accumulated evidence that inflation is rising.
For the month of February, the all-items CPI rose 4.5% at an annual
rate (a.r.), and is now up 3.0% in the past 12 months.
And this is not all energy price increases.
Core measures are up as well. The
traditional CPI excluding food and energy rose 3.1% (a.r.) for the month,
while the median CPI computed by the Federal Reserve Bank of Cleveland
was up 2.7% (a.r.).
Over the past year, these two core inflation indexes are up 2.4% and
2.4% respectively. The detail of the report includes
two noteworthy items. First,
owner equivalent rent (OER) increased 2.7% (a.r.) for the month, above its
recent 2.5% trend. As a result,
core service prices (services excluding energy services) accelerated a bit,
rising at a 3.7% annual rate in February, substantially above the 3.0% trend
of the past 2 years. Second,
core goods prices (commodities excluding food and energy commodities) were
unchanged. This would be good
news if it weren’t for the fact that the FOMC told us yesterday that we
should be worried about it. This brings us to monetary
policy: What will happen for the
remainder of this year? Will the
FOMC be content to continue with quarter-percentage-point increases?
Will Committee members be happy if the federal funds rate reaches a
neutral level of 4 to 4.5% this fall? Or
are policymakers going to tighten more quickly?
As I have pointed out repeatedly, a policy change today affects
inflation in 18 to 24 months. This
means if policy were neutral today, we would expect inflation to continue to
rise until the end of 2006. Rise,
that is, from a current trend that is slightly over 2.5%. This
suggests that without prompt action, we are headed for inflation of 3%. Yesterday’s statement has some
evidence that at least some FOMC members understand this and are considering
picking up the pace. For those
of you who haven’t read it, I recommend taking a minute to read the March
22 statement. Here’s the link:
www.federalreserve.gov/boarddocs/press/monetary/2005/20050322/.
There are two observations to
make about the statement. First,
the Committee is now clear that policy actions will be required to keep the
upside and downside risks of inflation equal.
Second, financial markets are being put on notice that increases in
inflation will elicit a response that is more aggressive than we have seen
thus far.
My own view is that, with inflation heading above 2.5%, now is the
time to start moving more quickly. Consumer
Price Inflation, Various Measures
For
previous updates, as well as my occasional essays on current policy
issues,Please visit my home page:
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