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MNI (Washington)

A run of surprisingly strong inflation readings is increasing the danger that the Federal Reserve could allow expectations for higher price increases to become entrenched unless it alters its policy stance, former Fed officials and staffers told MNI.

"The inflation numbers continue to come in significantly stronger than the Fed was expecting a few months ago -- stories about special factors are losing credibility," Jeffrey Lacker, former president of the Richmond Fed, said in an interview.

Consumer prices jumped 5.4% in June, a third month of higher-than-expected readings that raised fresh inflation concerns in financial markets and among some Fed officials, even if skyrocketing used car prices likely exaggerated the spike.

"Even though strong increases in several categories seemed to drive the headline numbers, the surge in this report is fairly broad," Lacker said.

Pressed on the issue of inflation during Congressional testimony this week, Fed Chair Jerome Powell stuck to the script that he expects recent increases to be largely transitory, pointing to used car prices that are likely to subside.

Still, the outsized nature of the rises, and what many see as their broadening nature, is giving some current and many former policymakers pause.

Dallas Fed President Robert Kaplan told MNI in an interview Tuesday that he was raising his own inflation forecast for this year and next given widening price pressures.

Against that backdrop, Powell was repeatedly asked during his semi-annual testimony on monetary policy as to why he was not more concerned about inflation or ready to act against it. He said the Fed needs more time -- around six months -- to look through recent price data that's muddied by comparisons to the depth of the pandemic, when prices plunged.

Charles Plosser, ex-president of the Philadelphia Fed, said the debate over temporary or permanent price pressures obscured the importance of how monetary policy reacts to those pressures.

"Policy needs to make sure that the temporary effects don't become more ingrained through rising expectations," Charles Plosser, ex-president of the Philadelphia Fed, told MNI.

"Monetary and fiscal policy are both very accommodative. This aggressiveness will be more important for future inflation than the bottlenecks or supply considerations that everyone seems focused on," Plosser said.

REACTION FUNCTION

In particular, the Fed's shift in framework into a stance that waits for persistent inflation to show up in the economy before any reaction, in contrast to a previously preemptive posture, complicates matters, Plosser said.

"The Fed is signaling it doesn't intend to change course any time soon as it seeks to achieve its inclusive employment objective," Plosser said.

"What happened in the 1970s was that monetary policy turned supply shock price increases into a more sustained inflation. The environment today seems remarkably similar."

Lacker also honed in on the framework shift as fundamentally altering the economy's inflation prospects.

"The thing that anchors inflation is expectations, and the Fed has deliberately tried to unanchor expectations with the framework," he said. "The news is filled with stories that, oh yes, they want to tolerate a little inflation above 2%, so everyone hears that and says, the Fed wants inflation above 2%."

Roberto Perli, a former Fed board economist, is still fairly sanguine about the prospect for inflation to come back to Earth. But he conceded recent readings would likely boost the Fed's own estimates.

"Higher inflation today, for whatever reason, raises the odds that inflation will stay higher at the end of the year, so an increase in the median 2021 inflation is very plausible in September," he told MNI.

Joseph Gagnon, another ex-board economist, told MNI he thinks the Fed will look through current readings but he's worried inflation will linger for longer than the core of the Federal Open Market Committee expects.

"I continue to predict more inflation in 2022 than almost anyone else," said Gagnon, who is forecasting 3% core inflation next year "with a wide confidence band."

The Fed is set to keep discussing when and how to begin reducing its USD120 billion monthly purchases of Treasury and mortgage bonds at its forthcoming meetings. Any discussion about interest rate increases is likely much further into the future, although some former officials believe a rate increase in 2022 is becoming inevitable.

MNI Washington Bureau | +1 202-371-2121 | jean.yung@marketnews.com