MNI INTERVIEW: Cleveland Fed Nowcasts Core CPI Rising 2.8% 1Q

--Headline CPI Expected to Jump 3.4% Annualized Rate in 1Q 

--Inflation Nowcasts Aimed At Improving Forecast Accuracy Over Longer 

By Jean Yung

     WASHINGTON (MNI) - Economists at the Federal Reserve Bank of Cleveland now

expect core consumer prices to rise at an annualized rate of 2.8% in the first

quarter of 2018 and overall prices to jump 3.4%, after the Labor Department

reported Wednesday that the official Consumer Price Index rose faster than

analysts expected in January.   

     The Fed bank's latest inflation forecasts show a firming trend for consumer

inflation, a key concern for central bank officials as they head into a policy

meeting in which they're expected to lift interest rates. These so-called

"nowcasts," updated on a daily basis, are a new tool adopted by the Cleveland

Fed as its economists hone near-term forecasting models that provide insight to

investors and policymakers weeks before the government releases its official

reports. 

     "Having good inflation nowcasts can improve forecast accuracy over a longer

time horizon. Our goal in having this model is to have better multistep accuracy

by getting the jumping off point right," Edward Knotek, senior vice president

and head of the macroeconomic forecasting group at the Cleveland Fed, told MNI

in an interview. 

     The bank also forecasts consumer inflation as measured by the personal

consumption expenditures price index, the Fed's preferred gauge for inflation.

It expects PCE and core PCE to rise at an annualized pace of 2.5% and 2.4%,

respectively, this quarter, which would meet the Fed's symmetric 2% inflation

target. 

     --CONSIDERABLE UNCERTAINTY 

     The Cleveland Fed claims its nowcasts are highly accurate, easily

outperforming a variety of competing nowcasts from alternative statistical

models as well as those of private professional forecasters. In fact, they are

on par with publicly available nowcasts from the Greenbook, the in-depth

analysis of economic conditions produced by the Federal Reserve Board of

Governors staff for Federal Open Market Committee meetings -- and have the added

advantage of being available in real time, compared to Greenbook figures which

are released to the public with a five-year lag. 

     Knotek cautioned, however, that the nowcasts also come with some notable

caveats. For one, this early in the quarter, the point forecasts have large

uncertainty intervals. 

     Having received only CPI data for the first month of the quarter, the

historical root mean squared errors for the model's quarterly forecast are

currently about 0.6 percentage point for headline PCE and 0.4 percentage point

for core PCE. 

     Roughly speaking, that means headline PCE inflation for the quarter, at an

annualized pace, would end up being between 1.9% and 3.1% with 70% probability.

Core PCE inflation, which tends to be more stable, would be expected to come in

a tighter range of 2.0% and 2.8% with 70% probability. 

     "Over time, as more and more data come in, these nowcasts become more

accurate. But even at the end of the quarter, there's still uncertainty around

them. So it's a question of how much uncertainty you're comfortable with,"

Knotek said. 

     --TREND INFLATION 

     That inflation nowcasting is quite different than attempting to discern the

trend inflation rate is another important distinction -- and one that gets at

the heart of the inflation conundrum for Fed officials. 

     A number of "idiosyncratic factors" affecting headline and core inflation

"are really not forecastable," Knotek said. Those include one-time shocks such

as mobile carriers slashing prices for wireless phone service plans last spring

which helped hold down overall price levels last year. 

     Fed economists and others have done a lot of work in trying to forecast

inflation over the medium term, but "at the end of the day, that work has been

somewhat disappointing," Knotek conceded. 

     "It's difficult to forecast inflation and GDP growth very accurately. So a

lot of the newer literature has looked at what economists can do better -- they

can forecast the very near future much better based on the incoming data,"

Knotek said. 

     "So we would potentially miss some key turning points in inflation. But

looking at the historical record, we're still lacking a foolproof way to

forecast that." 

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

[TOPICS: MMUFE$,M$U$$$,MT$$$$,MX$$$$]