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RPT:MNI INTERVIEW: Fed Economist Sees Downside Inflation Risk

By Jean Yung
     WASHINGTON (MNI) - A deceleration in the U.S. housing sector this year
could edge core inflation off the Fed's 2% target where it has sat since last
summer, Federal Reserve Bank of Dallas economist Jim Dolmas told MNI in an
interview. This would offer additional reason for Fed officials to watch and
wait before their next interest rate increase.
     Despite an increasingly uncertain economic outlook, the Fed has faced fewer
inflation worries in recent months. Core PCE inflation has posted at 1.9% or
2.0% in every month but one since March 2018. That's been a Goldilocks scenario
for the FOMC, with solid fundamentals and strong resource utilization bolstering
prices without triggering bottlenecks or sudden surges.
     But with growth stimulus fading and rate increases beginning to bite, most
housing indicators are trending lower. Since shelter costs account for a third
of the core PCE price index, falling rents and home prices could drag down trend
inflation for a while, Dolmas said.
     --HOUSING SLOWDOWN
     Low supply and solid demand have pressured housing costs to rise faster in
the past year than they did in the prior two expansions, when core inflation
also averaged around 2%. Owners' equivalent rent, an estimate of what homeowners
would pay in rent if they didn't own their homes, rose 3.4% over the past year,
compared to 3.1% during the 1992 to 2007 period.
     This has offset modest increases in health care prices, another large
contributor to the PCE basket. In the wake of cuts to Medicare payouts to
physicians and hospitals, prices for medical services have risen just 1.6%,
compared to 3.3% in the earlier period. Many of these payment cuts will last
well into the future, meaning the component is unlikely to rebound.
     Now it looks like rents may sag as well. Residential investment declined
further in the fourth quarter as borrowing costs climbed. In particular, market
conditions for apartments around the country have softened, according to surveys
by the National Multifamily Housing Council.
     "Given the slowing you see in the housing market and some surveys of
apartment market tightness, if housing inflation starts to fade, that's downside
risk," Dolmas said.
     --TARIFFS EFFECT
     With concerns swirling over weaker global growth and uncertain trade
policies, Fed officials have pledged patience on policy.
     In spite of a historically tight labor market, inflation has been
surprisingly muted. A range of internal Fed measures of underlying inflation
including the Dallas Fed trimmed mean PCE have been moving sideways over the
past five to six months, Dolmas said, adding: "there's no strong reason to
expect it would pick up."
     It remains to be seen whether President Donald Trump's tariffs have worked
their way through the economy, he said. Core goods prices have picked up a bit
but may rise more, representing a source of upside risk for inflation. A study
from the New York Fed this month estimated that the tariffs added about 0.3
percentage point to CPI last year.
     However, "I'd be inclined to look past that as a transitory thing," Dolmas
said.
--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com
[TOPICS: MMUFE$,M$U$$$]

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