- Key insight: The Federal Reserve's preferred inflation measure increased to 3.8% last month, a development that has been anticipated given the pricing impact of the war in Iran.
- Expert quote: "In the U.S., inflation is meaningfully above target, inflation expectations have been creeping higher, and the public is highly sensitive to rising prices. In this environment, if central bankers tolerate higher inflation today based on the hope of lower inflation in the future, the people we serve may lose confidence in our commitment to see inflation return to target." — Alberto Musalem, president of the Federal Reserve Bank of St. Louis.
- Forward Look: The Fed could normally look through the pricing impact of an oil shock, but many central bankers are beginning to worry about the public's confidence in returning inflation to 2%.
The Federal Reserve's preferred measure of inflation climbed to a three-year high in April, bolstering the growing sentiment among monetary policymakers that price growth should be the central bank's top priority.
The personal consumption expenditure, or PCE, price index increased by an annualized rate of 3.8%, up from 3.5% in March according to the Department of Labor's monthly report released on Thursday. The jump was slightly below the consensus forecast of 3.9%, but still nearly double the Fed's 2% target.
Notably, the headline inflation rate was above the target range for the Fed's primary monetary policy tool, the federal funds rate, which is set between 3.5% and 3.75%. The result of this is a negative real interest rate, an accommodative monetary stance that penalizes saving and incentivizes investment.
The Core PCE price index — a less noisy read of inflation that excludes food and energy prices — was 3.3% last month, indicating that real rates might still be positive, though less restrictive than in December when the Fed lowered the federal funds rate to its current level. At the time, Core PCE was 3%.
The rise in inflation comes as the Fed welcomes a new leader. Kevin Warsh was
The question for the Fed's monetary policy arm, the Federal Open Market Committee, as it approaches its meeting next month is whether or not it should treat increases in energy prices driven by the Iran war as a temporary shock — meaning it will resolve on its own without necessitating a rate adjustment — or something more long-lasting.
With inflation having been above the Fed's target for more than five years, Fed
In a speech delivered Thursday morning at an economic conference in Iceland, Federal Reserve Bank of St. Louis President Alberto Musalem noted the real policy rate is "below the FOMC's notion of long-run neutral" and inflation is well above the Fed's target.
Musalem, who is not a voting member of the FOMC this year, did not endorse any specific action for next month's meeting. Instead, he said the Fed should think twice about banking on increased productivity — specifically from gains in artificial intelligence — helping the U.S. economy grow its way out of inflation.
"In the U.S., inflation is meaningfully above target, inflation expectations have been creeping higher, and the public is highly sensitive to rising prices," Musalem said. "In this environment, if central bankers tolerate higher inflation today based on the hope of lower inflation in the future, the people we serve may lose confidence in our commitment to see inflation return to target."
Should inflation expectations increase, Musalem said, investors would likely demand a higher return for their investments, thus driving interest rates higher even without a rate hike from the Fed.
Several other Fed officials have expressed similar concerns since last month's FOMC meeting about the pace of inflation as a result of the war in Iran and its impact on global energy prices. Yet, they have also noted that the risks in the current environment are not one-sided. Higher prices and increased uncertainty could eventually weigh on businesses and drag down economic output.
Signs of a potential slowdown are already emerging. The Labor Department's Bureau of Economic Analysis also revised down its estimate of gross domestic product growth during the first quarter of the year on Thursday, citing less investment and a lower level of consumer spending than initially forecasted. Overall, the revision brought the projected GDP growth from 2% down to 1.6%.
