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A
new daily index released on Tuesday by the London-based ICE
Benchmark Administration (IBA) showed the expected pace of
consumer price increases over the next year rising from 3.5% on
Feb. 1 to 5.24% as of March 7. The index is based on trading in
the roughly $300 billion monthly market for inflation-protected
U.S. Treasury securities and in the $100 billion monthly market
for inflation swaps contracts.
Inflation anticipated over longer 10- and six-year horizons has
also turned abruptly higher since the onset of the Ukraine war,
with rates as of Monday around 2.43% and 2.73%, respectively,
significantly above the Fed's 2% annual price increase target,
the index shows.
Graphic: ICE inflation expectations index: https://graphics.reuters.com/USA-FED/INFLATION/akvezxjwrpr/chart.png
Longer-term inflation expectations are monitored closely by the
Fed as evidence of whether its policies are keeping inflation
psychology at bay. If longer-term expectations continue to rise,
it would indicate a loss of confidence in the Fed's ability to
control inflation - and make inflation itself harder to beat
without painfully high and fast interest rate increases.
"If that number keeps going up those that are setting monetary
policy will start to notice higher trend inflation expectations
getting priced into the system, and that might impact
decision-making," said IBA President Timothy Bowler, a former
U.S. Treasury official.
Inflation over the next year will be "heavily influenced by
commodity prices," and notably oil, he said. The question facing
the Fed now is whether that "all of a sudden spills over" into
the average rates of inflation expected years ahead.
Measuring expectations and assessing the influence of psychology
on the prices set by companies and the wages accepted by workers
is an often studied and highly disputed topic. Market measures,
deriving inflation rates from different security sales prices,
are one tool. Other measures rely on consumer or other surveys.
But however it is measured, policymakers generally feel that, as
much as controlling short-term inflation outcomes, they are in
the business of keeping long-run expectations stable and close
to the Fed's 2% target. A key to the U.S. central bank's success
in controlling inflation since the 1980s, in fact, is thought to
be public trust in its ability and willingness to do so.
RATE HIKES
February was a tough month for the U.S. central bank on that
front.
Headline inflation currently is far above target, and the Fed is
planning to raise interest rates at its policy meeting next week
and likely throughout this year, hoping to lower the headline
number before expectations shift.
The timing and pace of those increases in borrowing costs,
however, have become increasingly uncertain following the
invasion of Ukraine, which has produced a conflict driven
oil-price shock on a par with that seen in the 1970s. That
decade saw U.S. inflation become unmoored and forced the Fed to
ramp up interest rates so high that it triggered a recession.
Central bankers have a noted willingness to "look through" what
are perceived to be temporary increases in energy and commodity
prices, even large ones.
But Fed Chair Jerome Powell told lawmakers in Congress last week
that the shock from Russia's military actions could be a "game
changer" for world markets. If it leads to a steady move higher
in inflation expectations, it could trigger more aggressive
tightening of monetary policy.
IBA is a unit of Intercontinental Exchange, a firm that develops
and sells a variety of market analysis tools.
The inflation expectations index is being made public without
charge, Bowler said, to provide a daily view of an issue that
could shape central bank policy debates in coming months.
Other organizations publish inflation expectations data, such as
the 10-year-ahead expectations provided daily by the St. Louis
Fed. The U.S. central bank's staff in Washington combines a
broader set of both household survey and market data into a
single inflation expectations index, but it is only updated
every three months.
Events are moving faster than that.
Since the onset of the Ukraine war, oil prices have risen more
than 25% and are likely to keep consumer inflation higher this
year than otherwise might have been the case. The Consumer Price
Index is already exceeding a 7% increase on an annual basis, and
data due to be released on Thursday is expected to show prices
up by 7.9% in February from a year earlier.
(Reporting by Howard Schneider; Editing by Paul Simao)
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