Fed’s core PCE inflation concern threshold is 2.8%

The Federal Reserve’s preferred inflation gauge would have to hit a high of 2.8% to discomfort U.S. policymakers, according to a Reuters poll which also suggested the central bank would tolerate that rate for three months at least before it acts.

Stocks slumped and Treasury yields jumped on Wednesday after data showed annual U.S. consumer prices unexpectedly rose by the most in nearly 12 years in April, prompting earlier policy tightening bets.

In the 12 months through March, the core personal consumption expenditures (PCE) price index – the Fed’s preferred inflation measure for its 2% average flexible target – increased 1.8%, the most since February 2020.

That inflation gauge would have to rise as high as 2.8% to cause discomfort at the Fed, according to the median of 41 economists in response to an additional question in the May 10-13 poll. While forecasts ranged from 2.3% to a high of 4.0%, the most common response, or the mode, was 2.5%.

James Knightley, chief international economist at ING, said, “I have put 2.8%, but to be honest anything above 2.5%. However, it is more about how sustainable it looks rather than a specific monthly figure and has to be viewed in the context of what is happening to growth and jobs.”

“If we have core PCE above 2.5% in early 2022 as well, we will seriously have to consider an accelerated QE tapering with a rate hike before the end of the year,” he added.

When asked how long the Fed would tolerate that high rate of core PCE inflation before it acts, 36 of 41 economists said three months at least.

A breakdown showed five economists expected a less than 3-month threshold, while 12 economists predicted 3-6 months, seven said 6-9 months, nine penciled in 9-12 months and eight forecast over 12 months.

The poll consensus showed the core PCE price index would ease and average between 2.0% and 2.2% from next quarter through to end-2022 after hitting 2.4% this quarter. Those views were largely unchanged from April.

Only four economists penciled in that inflation measure at or above 2.8% – the expected discomfort rate for policymakers – in any quarter in the forecast horizon, confounding financial markets’ fears of higher price pressures.

“The Fed will likely continue to be dismissive of strength led by transitory price increases, but data over the coming months will be important for gauging the persistence of strong price increases,” noted Veronica Clark, economist at Citi.

“However, as April data releases so far have highlighted, there is substantial uncertainty around the path of inflation, and all economic data, in coming months.”

Driven by strengthening demand after reopening from the coronavirus-led curbs and massive fiscal spending, the U.S. economy was forecast to expand on average 6.5% this year and 4.1% next, up from 6.2% and 4.0%, respectively, predicted previously.

But jobs growth was expected to lag and take longer to sufficiently heal.

Asked when the U.S. unemployment rate would reach its pre-crisis levels, a majority of economists, or 35 of 50, said it would take over a year, including 15 predicting more than two years.

Fed Vice Chair Richard Clarida said on Wednesday last week’s weak employment report makes the pace of the jobs recovery “more uncertain”, adding the twin surprises of weak jobs data and stronger inflation in April hadn’t dented current plans.

“We don’t expect any action on the funds rate until 2024…Tapering is a different story; they just need substantial progress, not mission accomplished,” said Jim O’Sullivan, chief U.S. macro strategist at TD Securities.

Asked when the Fed would start scaling back its $120 billion monthly asset purchases, a majority of economists, or 31 of 51, said in the first quarter of 2022, while 13 respondents said in Q4 this year.

“The Fed is not going to panic after one startling CPI report, so you can expect to hear even more about transitory bottleneck inflation pressures over the next few weeks,” said Ian Shepherdson, chief economist at Pantheon Macroeconomics.

“But this report does mean that the first part of the higher inflation story – the reopening spike – is real. It’s no longer a forecast, and further hefty increases are coming…we continue to look for tapering at the end of this year.”