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Analysis : Fed May Lift Rates With Confidence as Inflation Shows Signs of Life

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02/14/2018 | 09:41pm CEST
By David Harrison 

The Federal Reserve is likely to welcome new signs of firming inflation, which should bolster its resolve to gradually raise interest rates this year.

Low inflation last year puzzled Fed officials, but most attributed the softness to transitory factors and predicted price pressures would strengthen over time to a level consistent with a healthy, expanding economy.

Officials in December penciled in three quarter-percentage-point increases in their benchmark short-term rate in 2018. Some have said they might favor four moves, depending on how the economy performs.

The inflation report released Wednesday "should probably cement in place the Fed's intent to hike rates" at its next policy meeting March 20-21, said Michael Feroli, chief U.S. economist at J.P. Morgan, in a note to clients.

"We now also think the odds are moving up that they also revise their guidance at that meeting from looking for three hikes this year to four, " he wrote.

Fed officials seek to keep annual inflation at 2%, a pace that suggests solid demand for goods and services and enables employers to raise wages. Slower inflation can reflect weakness, while faster price rises can distort spending and investment decisions.

The Labor Department said Wednesday its consumer-price index rose 0.5% in January, the fastest monthly increase since September and more than double the December rise of 0.2%. The so-called core CPI, which excludes volatile food and energy prices, rose 0.3% last month, up from a 0.2% gain in December.

The annual inflation rates were steady, however. The CPI was up 2.1% in January from a year earlier, unchanged from the 12 months ended in December. The year-over-year core measure was 1.8% higher in January, same as in December.

Fed officials prefer a different measure, the Commerce Department's personal-consumption expenditures index, which tends to run a bit cooler than the CPI.

The PCE was up 1.7% in December from a year earlier. The January figure is to be released March 1. Fed officials expect it to show a 1.9% annual gain by the end of 2018 and reach 2% by the end of 2019.

Soft inflation since the recession has worried the Fed, which sought to push it higher through low interest rates and other economic stimulus programs. Officials also want inflation to rise to 2% so they can raise interest rates higher, which would give them more room to cut borrowing costs if needed to fight the next recession.

There are risks that inflation could rise too much. That would force Fed officials to raise rates more aggressively than planned to keep it under control, which could push the economy into another downturn.

Fed officials already expect annual inflation to rise this spring and summer, due to the waning contributions of some one-time price drops a year earlier. The trick will be to separate the temporary effects from the more persistent.

Recent fiscal policy changes also could complicate the Fed's calculations. The federal tax cuts enacted in December and spending increases agreed to this month are expected to spur economic growth, at least in the short term and possibly longer.

Fed officials will have to decide whether these changes are likely to fuel too much inflation or enable the economy to grow faster without excessive price pressures.

Officials have said they would tolerate inflation running slightly above 2% for a time. But they haven't indicated how patient they are willing to be.

Write to David Harrison at david.harrison@wsj.com

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