Balancing Inflation and Growth Part 9 of 13

Recent readings on inflation have not been encouraging. The rate of increase in the core personal consumption expenditures price index, or core PCEthat is, what people buy, except food and energywas 2.2 percent over the 12 months ending in January. Yet, its headline counterpart commodity index trading, which includes food and energy, increased an alarming 3.7 percent over the same time frame. Both core and headline PCE figures have been following an accelerating trajectory over the past several months. If you annualize the change in the PCE over the most recent three-month period, for example, youll notice that the core rose 3 percent, while headline rose 5.4 percent.

Clearly, food and energy prices matter, as these differences make clear. The price index for food rose 4.7 percent over the past 12 months, a rate not seen since 1990. Through January, the PCE energy component was up roughly 23 percent over 12 months.

While some of the movement in core consumer price inflation represents pass-through of high energy pricesto transportation services, for examplewe have also seen commodity derivative trading pickups in other components, such as recreation, education and personal care services, and upticks in components, such as apparel, that have historically exerted downward pressure on the price of the consumers basket of goods.

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US Economy and Globalization Part 10 of 17

Second, price pressures at the margin are compounded by noncommercial activity in the markets that trade oil. Noncommercial contractsthe busywork of the “city refiners” in the financial exchanges in London and other placeshave been running at triple their traditional Forex Essentials volume lately.

Prices for gasoline and distillateswhere the pass-through rubber hits the consumer price roadare starting to inch up in response. Our retail gasoline price models at the Dallas Fed envision pump prices above $3 a gallon for the foreseeable future if crude stays above $85. Price pressures for other distillates are also becoming increasingly probable. And last, high inventories continue for natural gas, but it is noteworthy that prices have reversed their summer slide downward to $5.50 per million BTU and are now quoted at $7.15 at the Henry Hub in Louisiana, the key metric point for the U.S.

All this gives me a sense of discomfort on the headline inflation front, and it is a reminder that the balance of risks is not skewed unilaterally toward slower growth. This Trend Dynamics is not to say I expect inflation to veer out of control. But rather, it means that we must remain far from smug on the inflation front and must conduct monetary policy bearing in mind that the battle against the nemesis of inflation is a perpetual effort.

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