MNI INSIGHT: Fed Clings To View That Inflation Spike Will Ebb

Many Federal Reserve officials still view the U.S. inflation surge as temporary to a large extent and likely to ease in the second half of the year, despite having moved away from a controversial description of rising prices as “transitory,” MNI understands.

These policymakers are comforted by contained longer-run inflation expectations, particularly among market measures, although they are vigilant for possible spikes. They are also watching the potential that wage demands seeking to keep up with price spikes could create a worsening price spiral – a danger officials see as contained for now.

The Fed is set raise interest rates for the first time since the pandemic at its upcoming March meeting, but there is still active and open debate on the extent of eventual rate hikes and the pace needed to contain an inflation rate that surged to 7.5% in the year to January.

The lingering view that inflation is passing, if more stubborn than initially expected, means the core of the FOMC still favors gradual and predictable moves, even if they are prepared to act more aggressively should their benign predictions fail to materialize.

UKRAINE EFFECT

The Fed has yet to take a direct view on how the conflict in Ukraine will affect the U.S. economy, although the risks are two-sided – higher commodity prices are putting upward pressure on inflation but global growth may also take a hit.

Policymakers are hoping an initial round of monetary policy tightening, which many want to front load with a series of hikes in order to get ahead of the inflation problem before having a fresh look at the data in the second half of the year, will restrain consumer demand.

They are also looking at waning support from fiscal policy as reducing some pressure on prices. At the same time, these policymakers believe easing supply chain constraints will take some of the heat off inflation, as will rising interest rates around the world.

There’s a deep underlying sense among key policymakers that the Fed’s inflation undershooting that characterized the last quarter century may still represent the longer-term trend, and that its hold on the economy may eventually return despite a short-run spike.

At the same time, officials are comforted by a labor market they perceive as being very close to or at full employment, and which they believe is strong enough to withstand Fed rate hikes.