US inflation figures due later today will be scrutinised for indications of the strength of the economy and the outlook for interest rates.
America’s central bank, the Federal Reserve, is charged with keeping the Consumer Price Index at two per cent a year.
Labour market suggests economy is overheating
General weakness in the current inflation rate has slowed the speed at which the Fed has tightened policy. It has two mandates, one of which is to hit the two per cent inflation target and the other is to achieve “maximum employment”, usually defined as an unemployment rate of about 4.5 per cent.
But while the employment mandate has been more than fulfilled – suggesting the economy may be in danger of overheating and that rates ought to rise more sharply – US inflation year by year has tended to lag.
This has helped maintain what are extraordinarily loose monetary conditions. From December 2008, the target range of the key Federal Funds Rate was, for many years, at the historic all-time low of zero to 0.25 per cent.
But if the higher rates of inflation are maintained, this could open the door to more aggressive tightening. The CPI rose by 2.1 per cent in the year to January, and 2.2 per cent in the year to February, so would seem to be on an upward trajectory.
Debate over the inflation formula
Releasing the March figures on April 11, the Bureau of Labor Statistics noted that this was “the largest 12-month increase since the period ending March 2017 and higher than the 1.6 per cent average annual rate over the past ten years”.
It added: “The index for all items less food and energy rose 2.1 per cent, its largest 12-month increase since the period ending February 2017.
“The energy index increased seven per cent over the past 12 months, and the food index advanced 1.3 per cent.”
As in the UK and the euro-zone, there is some debate in the US about the inflation rate formula, with some arguing that a focus on consumer prices fails to give due weight to other types of inflation, including that generated by the price of assets, such as real estate and shares. Critics say a CPI measure can not only fail to detect asset-price bubbles, but can actually help to create them, by signalling to the authorities that policy ought to be kept loose when the reverse is the case.
Some say this is exactly what happened in the run up to the 2008 financial crisis.