By Howard Schneider
WASHINGTON, April 10 (Reuters) - When surging U.S. inflation peaked in June of 2022, driven by rising prices for energy but also for food, shelter, vehicles, and a host of other items, Federal Reserve officials assured the public in stern tones that they were on top of the situation and would follow through with steep interest rate hikes to cool the economy.
They will have the opposite job following the release on Friday of Consumer Price Index data showing the fastest increase
in monthly headline inflation since that breakout summer nearly four years ago, as they explain to an inflation-weary public why this round of price increases is different, driven by energy costs linked to the Iran war that likely won't require higher borrowing costs, particularly if the current ceasefire between Washington and Tehran holds and oil prices ease.
It could be a sensitive sales job after more than five years in which annual price increases have exceeded the 2% target the Fed has pledged to maintain, and as consumers digest the worst one-month jump in gasoline and diesel fuel prices, with a gallon of gas rising on average from around $3 in February to $4.15 and surveys showing rising inflation expectations.
"A higher (CPI) number will not be a surprise to anyone," San Francisco Fed President Mary Daly told Reuters a day before the release of the latest CPI data, but it wouldn't necessarily require a change in the U.S. central bank's current plans to keep rates on hold, or, perhaps, cut them. If the ceasefire holds and oil prices fall, inflation may ease and the Fed could eventually lower borrowing costs, she said; if oil prices and inflation are sticky, the Fed can stay on hold and wait.
It's less likely, Daly said, that inflation will surge and the Fed would have to chase it with higher rates.
Investors now expect the central bank to keep its policy rate on hold until well into 2027.
"We had work to do before we had the oil price shock; with the oil price shock, the work just takes longer," Daly said. "No one's really sure how long that will last. ... We could just be holding steady until we know that we are getting the job done."
It's a different tone than the one struck by the Fed in 2022 because the current inflation is different.
Beyond the dramatic 0.9% increase in monthly headline inflation in March, which would annualize to a rate exceeding 11%, underlying "core" inflation was actually a softer-than-expected 0.2% on the month and 2.6% on a year-over-year basis.
Core inflation excludes energy and food prices, which are closely linked to volatile commodity markets and not thought to reflect the broader supply and demand conditions that determine underlying inflation trends.
But food and energy prices are major parts of daily household spending and among the prices - from a gallon of gas to a pound of beef - that register deeply with consumers when they go up.
They influence survey responses that Fed officials watch to gauge if the public is keeping faith in the central bank's ability to control inflation, and they can influence political attitudes - a sensitive point for President Donald Trump and his fellow Republicans ahead of midterm elections in November and given his promises to make life more affordable.
SHIFT IN INFLATION EXPECTATIONS
For the Fed, the risk is that five years of above-target inflation has primed people to expect the worst, and the energy shock proves enough to reset public psychology in a way that makes inflation harder to control.
Data from the University of Michigan's regular consumer survey showed on Friday that the outlook for inflation over the next year jumped sharply to 4.8% in April from 3.8% in March, but more pointedly the outlook for inflation over the next five years also rose to 3.4% from 3.2%.
The Fed has good reason to believe this jump in inflation will be "transitory," a word it used initially as inflation rose during the COVID-19 pandemic, but discarded as the painful price pressures persisted.
Now it has to convince everyone else, at a time when its preferred measure of underlying inflation seems stuck about a percentage point above the target.
"They can't lower the policy rate in this situation. If they do they'll lose credibility," said former St. Louis Federal Reserve President James Bullard, currently the dean of the Mitch Daniels School of Business at Purdue University. "It's touch and go. If they stay where they are and inflation starts to tick down again, then that'll look great. If it doesn't, they're going to probably have to take action and show that they're more serious."
(Reporting by Howard Schneider; Editing by Paul Simao)
