Inflation Expectations Stay Steady as the CPI Edges Up
William Bednar and Mehmet Pasaogullari
After hovering in a narrow range between 1.0 percent and 1.6 percent for eight months straight, annual inflation as measured by the Consumer Price Index (CPI) increased to 2.0 percent in April. Part of the uptick is explained by food prices, which have increased more in the past three months than has been typical over the past few years. In April, for example, the food component of the CPI increased at a seasonally-adjusted annualized rate of 4.5 percent, and over the past three months it has averaged increases of 4.8 percent.
However, underlying inflation measures have also increased slightly, which suggests that something more than rising food prices may be at work. Annual inflation based on the core CPI, which excludes food and energy prices, has increased from 1.6 percent to 1.8 percent since the beginning of the year. Inflation based on the median CPI increased from 2.0 percent to 2.2 percent over that same time period, and inflation as measured by the trimmed-mean CPI increased from 1.6 percent to 1.8 percent.
Though these measures have risen modestly, measures of inflation expectations suggest that the increases do not signal a persistently higher rate of inflation.
Near-term inflation expectations as measured by the University of Michigan’s Survey of Consumer Sentiment (UM survey) and the Survey of Professional Forecasters (SPF) have not changed appreciably in the past few months. Although UM survey respondents increased their estimate of inflation over the next 12 months slightly between November 2013 and February of this year (from 2.9 percent to 3.2 percent), since February the median expected price change over the next twelve months has stayed at 3.2 percent. Likewise, the inflation rate expected over the next year by SPF participants has also been relatively stable, remaining in a range between 1.8 percent and 2.0 percent since the beginning of 2013. Most recently, it was 2.0 percent (2014:Q2).
Additional detail from the SPF provides information on how participants in this survey broadly see the risk to inflation in the near term. The SPF asks respondents to assign probabilities to particular ranges of expected year-over-year core CPI inflation for the fourth quarters of the current year and the following year. A high probability in one or two particular ranges suggests a bit more certainty for the inflation outlook, while a more balanced set of probabilities on the various ranges suggests less certainty. In the second quarter, survey respondents saw a 44.1 percent probability of year-over-year inflation being between 1.5 percent and 2.0 percent in the fourth quarter of 2014. They see over a 70 percent chance of inflation being between 1.5 percent and 2.5 percent in that same quarter. For the fourth quarter of 2015, most participants again believe that inflation will be between 1.5 percent and 2.5 percent. However, they assign similar probabilities to two ranges, the 1.5–2.0 percent range (32.7 percent) and the 2.0–2.5 percent range (31.9 percent).
Longer-term inflation expectations have been relatively consistent also. Before ticking down to 2.8 percent in May, the median expectation for price changes over the next 5 to 10 years from the UM survey had been at 2.9 percent since the beginning of 2014. Similarly, from the SPF, expected average annual inflation over the next 5 years has been around 2.1 percent since mid-2013, while over the next 10 years it has been between 2.2 percent and 2.3 percent since the fourth quarter of 2012.
Market-based measures of inflation expectations give a general sense of how investors view the prospects for future inflation. Two such measures are break-even inflation rates and inflation swap rates. Similar to the survey based measures, these indicators have been rather stable over the recent past as well. The 10-year break-even inflation rate has remained between 2.1 percent and 2.3 percent since the beginning of 2014, and the 10-year inflation swap rate has been between 2.4 percent and 2.6 percent. As recently as the May 19, 2014, the 10-year break-even inflation rate was at 2.2 percent and the 10-year inflation swap rate was at 2.5 percent.
These various measures suggest that over the recent past, inflation expectations have remained well anchored. Both survey- and market-based measures have held steady in relatively narrow ranges for some time. Additionally, the probabilities provided by the SPF show that in addition to the average expectation for inflation being stable over time, there is also some degree of certainty over the expected range that core inflation might fall in, at least for the next few years.