US: Market inflation expectations are on the rise – Westpac

Elliot Clarke, Research Analyst at Westpac, explains that there has long been an expectation that inflation would take root in the US economy and see the PCE measure of consumer inflation tend to the FOMC’s 2.0%yr medium-term objective – at the very least.

Key Quotes

“But while market inflation expectations have moved higher, consumer sentiment survey inflation measures and the PCE inflation data itself has struggled to accelerate.”

“A key factor behind this absence of consumer price inflation is the lack of momentum in wages growth.”

“While we expect employment growth to continue slowing in 2018, it is still likely to carry enough momentum to push the unemployment rate down to 3.8%. All else equal, this lack of labour market slack should drive wage growth higher.”

“On the whole, there is growing evidence that reduced slack in the labour market is supporting stronger wage outcomes. The more slack is reduced, the greater the likelihood that this uptrend will accelerate. (Note tax reform should also be supportive in 2018, with reports circulating of one-off and ongoing wage raises).”

“The impact on inflation though is not necessarily one for one. The reason being that demand-led inflation has limited support. Households have continued to dissave in recent years such that their savings rate is near record lows. Further, in a rising rate environment, consumers are likely to become far more mindful of the rising interest cost (and risks) they are taking on by using credit. They are also being affected to a greater degree by the cost of life’s essentials – rent growth well in excess of headline inflation being a prime example.”

“For inflation and policy then, the improved wage growth trend is more likely to see inflation consistently around target than materially above it as the economic growth cycle is sustained. A need to raise the fed funds rate more than three times this year is therefore unlikely.”