Fed's latest easing came after inflation accelerated

Inflation has begun to accelerate in the United States. And not for the first time, the Federal Reserve may be falling behind the curve.

Last week, the Labor Department reported that the consumer price index rose 0.4 percent in January. From January 2010, consumer prices rose 1.6 percent.

The consumer price index excluding food and energy rose 0.2 percent in January. This was the fastest pace of increase in 15 months. From January last year, this measure of core inflation rose 1.0 percent.

Inflation in the 16% trimmed-mean consumer price index and the median consumer price index, other measures of core inflation monitored by the Federal Reserve Bank of Cleveland, also registered increases in January.

	Percent change from previous month
	Aug	Sep	Oct	Nov	Dec	Jan
CPI	0.2	0.2	0.2	0.1	0.4	0.4
CPI less food & energy	0.1	0.0	0.0	0.1	0.1	0.2
16% trimmed-mean CPI	0.1	0.1	0.1	0.1	0.1	0.2
Median CPI	0.1	0.1	0.1	0.1	0.1	0.2
	Percent change, past 12 months
	Aug	Sep	Oct	Nov	Dec	Jan
CPI	1.1	1.1	1.2	1.1	1.5	1.6
CPI less food & energy	0.9	0.8	0.6	0.8	0.8	1.0
16% trimmed-mean CPI	0.8	0.8	0.7	0.8	0.8	1.0
Median CPI	0.5	0.6	0.5	0.6	0.7	0.8

So the trend in the inflation rate appears to be up, and it will probably continue to accelerate in coming months. Other recent data show that resource utilisation rates have continued to improve in recent months, which would typically be followed by higher inflation.

Last week, the Federal Reserve reported that industrial capacity utilisation was 76.1 percent in January, slipping from the 28-month high of 76.2 in December as the output of utilities fell 1.6 percent in January after unseasonably cold weather boosted the demand for heating in December.

Manufacturing capacity utilisation, however, rose to 73.7 percent in January, the highest rate since August 2008.

Earlier this month, the Labor Department had reported that the unemployment rate had declined to 9.0 percent in January. Although still high, this was the lowest unemployment rate since April 2009.

With inflation probably on an uptrend, it is now quite safe to say that the 12-month inflation rate of the overall CPI bottomed in July 2009 while that for the CPI excluding food and energy probably bottomed in October last year.

This means that the Federal Reserve may have introduced its latest Treasury securities purchase programme -- popularly called quantitative easing 2 (QE2) -- after inflation had started to re-accelerate. QE2 had been officially announced after the Fed's monetary policy meeting on 3 November 2010, one month after the bottom in core inflation and 16 months after the bottom in headline inflation.

It is hard to say whether the Fed would have introduced QE2 in November if they had known with the same degree of certainty that we now have that inflation was already accelerating. After all, the Fed is also concerned about the unemployment rate which, at 9.0 percent in January, remains high.

However, it probably does not help the Fed's monetary policy-making that the bottom in core inflation -- the measure that it monitors more closely -- had followed the bottom in headline inflation by 15 months, one of the longest lags on record. The duration of the lag was surpassed only by the 17-month lag after the prior recession.

In the last cycle, the ability of food and energy prices to rise faster than core prices persisted throughout the expansion phase (see "Elevated US headline inflation proves persistent"). By focusing on the lower core inflation, the Fed may have accommodated the excessive credit growth that eventually resulted in high overall inflation as well as contributed to the housing bubble and culminated in a financial crisis and the worst recession since the Great Depression.

With headline inflation again being much quicker off the starting blocks than core inflation this time, let's hope that this cycle will not end the same way as the last one.