Inflation, as (un)expected | FT Alphaville

Inflation, as (un)expected

The CPI numbers for October are out from the US Labor Department, with the monthly 0.2 per cent increase a bit lower than the expected 0.3 per cent.

But here’s the chart we usually focus on:

Over the last twelve months, core CPI climbed 0.6 per cent, or “the smallest 12-month increase in the history of the index, which dates to 1957,” according to the BLS. There’s been a slight divergence between the core and headline numbers in recent months, with the majority of it accounted for by higher gas prices — but even then, the headline figure only climbed 1.2 per cent.

The point is that inflation remains very low, and these numbers obviously reinforce the part of the Fed’s case for QE2 that inflation is running below trend.

We don’t have much to add about this particular report, so instead we’ll say something quickly about expected inflation. A couple of days ago Menzie Chinn updated this chart, which shows the breakeven inflation rates (the difference between Treasuries and Tips yields) for five and 10 years out:

Two things to note here.

First, having said on Tuesday (along with everyone else) that rising bond yields made the Fed’s case for QE2 vulnerable to the charge that it just wasn’t working, it’s only fair to look at an indicator that is moving in the intended direction.

That is, since the Fed signaled that it would pursue further easing, inflation expectations have trended upwards, if sometimes erratically. And as we we’ve also mentioned several times, when short-term rates are at the zero lower bound, managing inflation expectations matters hugely.

On top of that, rising inflation expectations and the rise in bond yields might very well be linked. As commenter Diogenes pointed out in our Tuesday post, rising yields on longer-dated bonds would be consistent with increased longer-term inflation expectations, and that’s as valid an explanation as any (though we remain confused as to how to read this, and doubt we’re the only ones).

Either way, you can get a better sense of the change in inflation expectations from this chart, which shows the same thing as the one above but goes back to the start of the year. (HT Free Exchange):

The second (and rather obvious) point to make is that even with this climb, expected inflation remains well below the Fed’s implicit 2 per cent target.

We asked in our post on Tuesday why more of the FOMC’s defenders don’t emphasise this point, but the likely explanation is simple politics: persuading the public that more inflation is a good idea after decades of warning against it is no easy task, and might well backfire.

But in our struggle to understand whether QE2 is a good or a bad idea, we’ve heard plenty of reasonable arguments against it — but runaway inflation doesn’t seem like one of them.

Related links:
On the ho-hum inflation report – FT Alphaville
The doves respond, quietly – FT Alphaville