MNI: Inflation Expectations Drop On Gas Little Comfort For Fed

Consumer expectations for inflation have shown tentative signs they may turned down from peaks reached earlier this summer but the easing provides little comfort since the moves are primarily due to a fall in gas prices that may still prove volatile, regional Fed bank economists and outside advisers told MNI.

"It seems like there may be some evidence that we're past a peak, but in an absolute sense, these short term inflation expectations measures are still very high," said Ed Knotek, a senior vice president and associate research director at the Cleveland Fed.

As households’ expectations about future inflation can influence realized inflation, the turn in survey respondents' price expectations in the Indirect Consumer Inflation Expectations measure, the University of Michigan's Survey of Consumers, and the New York Fed's Survey of Consumer Expectations from very high levels is positive, even if predicated heavily on gas prices.

"I view the decline that we've seen there recently as really reflecting the moves in gasoline prices," said Knotek. "And in some sense, I wouldn't be surprised if that helped push down some of those longer term inflation expectations measures too."

ELEVATED DISAGREEMENT

Consumer surveys comprise thousands of responses, and policymakers have historically put focus on the median household response, but surveys are also now showing historically elevated disagreement.

The Michigan survey shows the 25th and 75th percentile of longer-term inflation expectations is the widest it’s been since the late 1980s and the New York Fed's consumer survey is realizing a similar phenomenon.

The current and former Fed economists expressed little surprise by the increased dispersion, and pointed to uncertainty around the forecast mean.

"The dispersion can be due to many things and you do notice that it rose much earlier before any tightening had started" from the Fed, said Raphael Schoenle, former deputy director of the Cleveland Fed’s Center for Inflation Research. "This reflects huge uncertainty and how persistent that is."

Michael Weber, an outside adviser to the Cleveland Fed, said mean expectations might be less interpretable now and might be worse as an indicator relative to the signals from the wider array of responses. "Looking at the uncertainty and understanding where it comes from, it's certainly still very useful for the Fed," he said.

NEED A TREND

The University of Michigan and New York Fed surveys also show more respondents viewing deflation on the horizon, primarily due to an uncertain outlook while a minority of economists pointed to elevated recession risks. (See: MNI INTERVIEW: U.S. Consumers' Price Expectations Soften - UMich)

Uncertainty around inflation, supply chains, the pandemic domestically and internationally all can contribute to the idea that there will be deflation, a New York Fed economist who's studying the issue told MNI. About a quarter of respondents in the NY Fed survey see deflation three years ahead.

Still, the economists said they'd like to see a more persistent fall in inflation expectations and it's "reasonable" to expect the dispersion to decrease as inflation prints begin to fall toward the Fed's 2% goal.

"Just relying on the situation that gas prices have come down somewhat is no indication to me at all that you should actually relax and lean back and can conclude victory," said Weber. "You want to see a broad-based decrease and a sustained decrease in the end."

Schoenle agreed preliminary indications are going in the right direction for policymakers. "But you want to see more of a trend," he added.