A sharp upward spike in the level of core inflation dissuades the notion that the US teeters on the edge of recession, according to Joshua McCallum, head of fixed income economics at UBS.
Core inflation is an important measure of the economic outlook, because it removes from the official statistics the most volatile and essential items, such as energy costs.
The thinking behind that is, people have no choice but to buy energy, so a movement in price does not particularly reflect a change in demand.
Core inflation thus seeks to measure the movement in the price of goods and services that are most sensitive to changes in demand. So core inflation rising materially implies that there is more demand in the economy, which should be good for growth, while falling core inflation implies less demand and less economic growth.
McCallum commented, ‘Amidst all the concerns about US growth and the risks from deflation, something rather surprising has been happening: core inflation in the US has been accelerating, and accelerating quite rapidly. This matters a lot. The Fed has a dual mandate, covering unemployment and inflation. This is a very different mandate from targeting growth and oil prices, yet the market seems to be behaving as if this is what the Fed mandate actually was.’
He added, ‘The Fed’s expectation for core PCE inflation by the end of this year is 1.6 per cent, and the most recent number is already 1.7 per cent. Their expectation for the unemployment rate is 4.7 per cent, and it is already not far off at 4.9 per cent. So the progress against the Fed’s mandate looks pretty good, despite the market’s reaction. In fact, they are not that far off the Fed’s longer run expectations of 2 per cent for core PCE and spot on their expectation for 4.9 per cent for the unemployment rate.’
The targets that the US Federal Reserve work towards are only realistically achievable if economic growth is happening.
That core inflation is moving towards the Federal Reserve’s target implies that growth is picking up, along with inflation.
The picture for the UK is somewhat less clear. Although the headline rate of inflation rose in January, core inflation fell to 1.3 per cent, from the previous 1.4 per cent.
In 2012, when official GDP statistics indicated that the UK was in ‘double dip’ recession, the core inflation number continued to be robust. It was the GDP numbers that were later revised upwards.
[Source:- Whatinvestment]
