Shoppers carry bags while crossing the street. (Photographer: David Paul Morris/Bloomberg)

U.S. Inflation's Cold Streak Seen Ending -- For Real This Time

(Bloomberg) -- After five months of misses on U.S. inflation, economists say this time is different.

A report Thursday is due to show that consumer prices excluding energy and food -- the so-called core index -- rose 0.2 percent in August from the previous month, according to the median estimate of analysts surveyed by Bloomberg. Analysts have stuck with the 0.2 percent projection heading into every run of the Labor Department data this year -- a figure that’s proved too high each month since March. That’s resulted in the weakest stretch of price growth since 2010.

With unemployment near a 16-year low, the data have spurred some Federal Reserve officials to start questioning one of their bedrock theories -- that a strong labor market will cause inflation to drift upward. While central bankers are likely to forge ahead next week with plans to start reducing their $4.5 trillion balance sheet, another undershoot on core CPI may mean a delay for the December interest-rate increase that the Fed has telegraphed for several months.

A rebound in hotel prices, the weakening dollar and the economy’s general strength are expected to buoy prices. Economists are signaling more confidence in their August forecasts, as 80 percent of those surveyed estimate that inflation accelerated, up from 71 percent in the July poll. While year-over-year growth in the core index probably slowed to 1.6 percent, which would be the weakest since January 2015, Fed officials have indicated they’re looking more closely at the month-to-month trends for an upturn in inflation.

“Inflation matters for the December decision, which is still very much up in the air,’’ said Jonathan Wright, an economics professor at Johns Hopkins University in Baltimore and a former Fed economist. If core price gains remain low through the end of the year, “it would be too hard to insist that inflation is still on track.’’

Price Target

Fresh forecasts from Fed policy makers next week will reveal whether an interest-rate hike is still on track for December. While the central bank bases its 2 percent target on a separate Commerce Department price index that will be updated Sept. 29, Thursday’s report provides an earlier look at inflation, and many of the CPI components feed into the Fed’s preferred index.

Analysts don’t expect Hurricane Harvey to have had a significant impact on core inflation in August. Gasoline prices sharply rose following the gulf storm, which cut U.S. fuel-making capacity by almost a quarter, but the broader effects will probably be delayed until September, economists said.

Even so, with Hurricane Harvey boosting gasoline prices, the headline CPI probably rose 0.3 percent, the highest since January, bringing the year-over-year gain to 1.8 percent from 1.7 percent in July, the Bloomberg survey median shows. While the Fed officially targets overall inflation, officials and economists look at core indexes to better gauge underlying inflation.

“The core inflation numbers are going to be some of the lesser-affected of the key data between now and December,” said Stephen Stanley, chief economist at Amherst Pierpont Securities.

The jobless rate declined steadily as the Fed pursued a gradual pace of interest-rate increases starting in late 2015 and is now below the level central bankers deem consistent with full employment. Despite that, inflation has drifted away from the 2 percent target since slightly exceeding it in February.

Temporary Weakness

Fed policy makers “seem to believe that inflation weakness is temporary, and they are probably right on that,” said Roberto Perli, a former Fed official who’s now a partner at Cornerstone Macro LLC in Washington. “But the more weak data we get, the more uncertain they will be about that interpretation and therefore the higher the likelihood of a postponement.”

Fed Governor Lael Brainard has warned against raising borrowing costs again until prices move closer to the central bank’s 2 percent goal. “My own view is that we should be cautious about tightening policy further until we are confident inflation is on track to achieve our target,” Brainard said this month in a speech in New York.

By contrast, Cleveland Fed President Loretta Mester, one of the central bank’s more hawkish officials, said she would be comfortable raising interest rates this year despite tepid price growth. “There hasn’t been enough evidence that inflation is on a different trajectory now,” she told reporters in Pittsburgh last week.

Wright, of Johns Hopkins, said that rather than attributing inflation trends to temporary factors -- a mistake Fed officials made in the other direction in the 1970s -- he “would argue instead that the current tightness in the labor market is not sufficient to drive inflation up meaningfully.’’

The inflation debate could be further muddled by Harvey and Irma, which may temporarily boost inflation by pushing up food and energy prices.

“Were that to happen, I would expect the Fed to dust off the transitory argument for at least the first few months and dismiss any inflation acceleration, but hawks will embrace any acceleration as a reason to get on with normalization,” said Ward McCarthy, chief financial economist at Jefferies LLC in New York and a former Richmond Fed researcher.

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