(Bloomberg) — An acceleration in monthly core consumer prices seems likely to reinforce the Federal Reserve’ determination to raise interest rates to fight inflation, though the decision on next week’s move will be a tough call amid ongoing concern about financial turmoil.
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February’s consumer price index, excluding food and energy, increased 0.5% last month and 5.5% from a year earlier, according to Bureau of Labor Statistics data out Tuesday. Economists see the gauge as a better guide to underlying inflation than the headline measure. CPI overall climbed 0.4% in February and 6% from a year earlier.
The challenge for the Fed now is how to prioritize inflation that is still far too high with growing financial stability risks in the unraveling of Silicon Valley Bank. Authorities stepped in over the weekend to provide a new backstop for banks to protect uninsured depositors.
“This CPI print underscores how they don’t have the luxury to sit around and wait,” said Derek Tang, an economist at LH Meyer/Monetary Policy Analytics in Washington. “The weekend intervention was also meant to contain the financial crisis to create room for continued monetary tightening. That way, they don’t want to pick between financial and price stability.”
While tentative signs of stability appeared to be returning to banking stocks that have been hammered in the aftermath of the collapse of SVB, Chair Jerome Powell and his colleagues may worry that it’s too soon to tighten policy again while the fallout from the failure is still difficult to judge.
Also weighing is the argument that the Fed’s aggressive 450 basis points of tightening over the last year is already straining the financial sector and SVB’s predicament shows the lagged effect of past rate hikes is starting to bite.
“It is a tough call for the Fed regarding whether they decide to continue tightening with a quarter point hike or stand pat,” said Kathy Bostjancic, chief economist at Nationwide Life Insurance Co. “If signals from the financial markets suggest their emergency actions on Sunday contained the financial stresses, the Fed officials might be persuaded to raise rates 25 basis points.”
Still, “inflation is not the sole focus of the Fed, as it now needs to take into consideration financial stability and lending conditions,” she said.
What Bloomberg Economics Says…
“February’s CPI report shows that inflation is not vanishing quickly, and there remains a compelling need for the Fed to continue raising rates. A 25 basis point move would be appropriate at the March FOMC meeting, followed by a couple more until the Fed reaches a terminal rate of 5.25%. “
— Anna Wong and Stuart Paul, economists
To read the full note, click here
Investors, who were betting on the possibility of a 50 basis-point hike at the Fed’s March 21-22 meeting prior to the banking crisis, are now pricing in the likelihood of a 25 basis-point hike with a pause an option. Two-year Treasury yields, which largely reflect expected Fed policy over that period, rose more than 30 basis points to as high as 4.37% Tuesday.
The details of the price report were “not encouraging” for the Fed with core services inflation, excluding housing – a focus of Powell – accelerating, wrote Neil Dutta, head of US economic research at Renaissance Macro Research LLC, in a note to clients.
“Today’s CPI data are a reminder that the inflation fight is not over,” he wrote. He expects a 25 basis-point hike next week, noting it would be a half point if not for SVB.
If the Fed is successful in prevent a broader crisis and keeping it narrowly focused, then policy makers will return to hiking, said Ethan Harris, head of global economics research at Bank of America Corp.
“We are in the middle of a stress event and so it’s very hard to predict where things are going,” he said on Bloomberg TV following the CPI report. “Our view is ultimately the ringfencing works and the Fed goes back to hiking interest rates. Ultimately, the Fed is going to end up having to fight inflation.”
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