Chief economist update: Inflation is heading Fed's way

Had it not been for Trump's attack threat on Syria (now retreat) the other day, financial markets would have been dissecting the minutes of the Fed's 20-21 March FOMC meeting.

There really was nothing significant except for a sentence alluding to a more aggressive path towards normalisation.

"A number of participants indicated that the stronger outlook for economic activity, along with their increased confidence that inflation would return to 2% over the medium term, implied that the appropriate path for the federal funds rate over the next few years would likely be slightly steeper than they had previously expected."

The financial markets would have had a negative knee-jerk reaction. But the same way as RBA Governor Philip Lowe explained in his address to the Australia-Israel Chamber of Commerce, it's a scenario " which interest rates are increasing is one in which the economy is strengthening and income growth is also picking up."

But whether or not upcoming Fed rate hikes would be steeper is largely dependent on where inflation's going. The minutes revealed that: "all participants expected inflation on a 12-month basis to move up in coming months."

The latest US CPI report gives credence to this expectation. The headline CPI shows the annual inflation rate accelerated to 2.4% in March from 2.2% in the previous month. Similarly, the less volatile core inflation (ex- food and energy) rate moved up to 2.1% from 1.8%.

However, note that it is the core PCE price index that is tied to the Fed's 2% target. The latest stats show it had been consistently accelerating since August last year but, at 1.6% in February, remains below target.

Because of its strong positive correlation with the CPI measure of inflation, chances are the PCE price index will reflect the gentle upward trend in consumer prices when the March update is released at the end of this month.

More so given that other price measures have moved higher. US import prices increased by 3.6% in the year to March - the fastest rate since April last year - from 3.4% in the previous month.

Inflation at the producer level is also accelerating. The producer price index - final demand (PPI-FD) rose by 3% in the year to March from 2.8% in the previous month. Other measures showed similar acceleration: PPI less food and energy went up to 2.7% from 2.5%; PPI less food and energy and trade services, rose by 2.9% from 2.7%.

The strength in the US labour market would make it easier for producers and importers to pass on these higher prices onto consumers.

Ben Ong is the Director of Economics and Investments at Rainmaker Group. He previously worked as a fund manager, economist, asset allocation strategist, portfolio analyst and stock market analyst. Check out his economics analysis here.

Read more: FedminutesPPIPCEAustralia-Israel Chamber of CommerceFOMCRBA Governor Philip LoweSyriaTrumpUS CPI
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