MNI INTERVIEW: Inflation Likely Higher Than BEA Says-Fed Econ

--Fed Economist's Data Sees Jan PCE Infl 1.6% V 1.8% Dec After Annual Revisions

--Inflation To Rise in 2018; No Material Impact on Core Infl From Weaker Dollar

By Jean Yung

     WASHINGTON (MNI) - Tight labor markets should have a more evident effect on

price levels this year as headwinds from the U.S. dollar exchange rate and

energy prices dissipate, pushing inflation toward the Federal Reserve's 2%

objective, Dallas Fed Senior Vice President Evan Koenig told MNI in an exclusive

interview. 

     Koenig, a principal policy adviser who prepares the Dallas Fed chief for

FOMC meetings, also suggests that inflation is actually higher than the Commerce

Department's current estimates, using an experimental forecasting model. 

     Their latest "nowcast" for the personal consumption expenditures price

index, the Fed's preferred gauge of consumer price levels, saw overall inflation

in their series reaching 1.9% in September and November before retreating to

1.8% in December and 1.6% in January. 

     The model's estimates rely on lagged inflation rates as well as

survey-based price data from the Institute for Supply Management and regional

Fed banks. The nowcast is updated as data becomes available and predicts a

"true" headline PCE inflation rate that accounts for projected annual revisions

out of the Bureau of Economic Analysis. 

     Current BEA estimates for headline PCE inflation are 1.7% in December and

1.8% in November. It won't release figures for January until March 1, and will

issue annual revisions to the data in the summer. 

     --INFLATION HEADED HIGHER

     "Even though the model is predicting a pretty strong inflation rate for the

month of January," at roughly 4% annualized, "January 2017 was an exceptionally

high number" that will drop out of calculations, Koenig said. The 5.2% rate that

month was the second highest in the expansion so far. 

     The Fed's 2% inflation objective is defined in terms of headline inflation,

which directly affects households' purchasing power. But officials have

struggled to meet that goal. Headline inflation fell short in 2014-2016 due to

declining oil prices and the dollar appreciation's impact on import prices. Last

year, some of that drag reversed, yet policymakers struggled to explain why

inflation did not tick higher amid labor market improvements.  

     Koenig believes the relationship between slack and inflation remains intact

and will come to the fore this year. 

     "Some of the headwinds holding down inflation seem to be dissipating and I

would expect the effect of tight labor markets to become more evident, and to

see inflation move toward the Fed's 2% objective over the course of 2018," he

said. "If you look at 12-month or 6-month inflation rates, many measures of

inflation have bottomed out and are headed back up." 

     --LAGGED EFFECTS

     One reason Koenig and other Fed economists think inflation has run below

target over the last couple years is due to certain lagged effects. Koeing said

he did not expect inflation to rise in 2017 because the declines in import and

energy prices in 2015 and 2016 were still filtering through to the bank's core

inflation rate a year later.

     "One possibility is, if you've gone through a period with falling import

prices and energy prices, that translates into lower wage demands on behalf of

workers, and that could influence prices on a wide variety of goods and

services." 

     In 2017, the dollar has stopped rising and energy prices have stopped

falling. "So here in 2018 we're not expecting a drag on trimmed mean inflation.

We think the effects of slack will be more evident and not be muddied up by

those other influences," he said. 

     Koenig noted that, to date, headline PCE inflation hasn't been that

different from the trimmed mean, which likely means the dollar movements have

not yet been large enough to have a material impact on trend inflation. 

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

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