Inflation expectations fall in key Fed survey

• Key insight: One of the Federal Reserve's preferred methods for gauging inflation expectations painted an improving — if not quite optimistic — outlook on inflation expectations. 
• Expert quote: "The ability to look through supply shocks depends, in part, on inflation expectations and underlying inflation. Expectations remain well-anchored." — Anna Paulson, president of the Federal Reserve Bank of Philadelphia
• Forward look: Inflation expectations could influence the FOMC's next interest rate decision, but they will have to be factored in alongside additional information about observed inflation and the job market.

NEW YORK — Consumer inflation expectations for the year ahead have moderated but remain above the Federal Reserve's 2% target.

The Federal Reserve Bank of New York released the July edition of its monthly summary of consumer expectations report on Friday. The often-cited report showed that participants expect inflation to run at 3.6% over the next year, down from 3.7% in June. 

Three- and five-year inflation expectations were flat at 3.3% and 3%, respectively.

The drop in one-year inflation expectations was driven primarily by lower expectations for rent growth, which fell from 8.3% in June to 5.9%. Healthcare and gold price growth also trended down slightly. Meanwhile, expectations around gas price growth nearly doubled from 1.5% to 2.9% and college education expenses nudged up from 5.8% to 5.9%.

Expectations play a crucial role in shaping the trajectory of inflation. When expectations become "unanchored" — meaning consumers, businesses and markets begin to expect rapid price increases and spend accordingly — the task of curbing inflation becomes difficult and often requires a more aggressive response from the central bank. 

Fed officials have characterized inflation expectations, as measured by the New York Fed's consumer expectations survey, as being "well anchored."

"The ability to look through supply shocks depends, in part, on inflation expectations and underlying inflation," Federal Reserve Bank of Philadelphia President Anna Paulson said in an essay this week. "Expectations remain well-anchored."

Paulson joined the nine-member majority on the Federal Open Market Committee that voted to hold the Fed's benchmark interest rate unchanged at last week's monetary policy meeting. The decision came in the face of persistently elevated inflation and a recent uptick in oil prices, but Paulson said she was hopeful that upward pricing pressures would dissipate without a tightening of monetary policy.

Others on the committee were not as willing to let the situation play out. Three reserve bank presidents voted against the group's decision, arguing instead that interest rates should have been raised to address inflation, which has run above 2% for five years. For this cohort, the slight improvement in near-term inflation outlook might be less relevant than the fact that medium-term expectations remain stubbornly above target.

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"In my view, now is the time for the FOMC to act to speed the return of PCE inflation to our 2% objective and deliver on our commitment to price stability for the American people," said Cleveland Fed President Beth Hammack, one of the three dissenters. "The longer that high inflation persists, the more challenging and costly it can be to bring it back down."

The New York Fed's report also showed weakening confidence in the U.S. labor market, with 42.8% of respondents saying they expect unemployment to be higher a year from now, up a little more than a percentage point from June. 

While far from an indictment of the job market, the reading is consistent with what Fed policymakers have noted anecdotally about deteriorated confidence among workers. In a speech this week, Fed Gov. Lisa Cook said workers and businesses alike have a "less favorable" view of the economy than what top-line data figures might convey. 

"National consumer sentiment data bear out this observation," Cook said. "Consumer sentiment, by many measures, is lower than one would expect in a solid labor market, and perceptions of job availability have continued to worsen. In outreach calls, I hear that vulnerable households are especially dissatisfied with the economy."

The Bureau of Labor Statistics' latest jobs report, also released Friday, substantiates some of these concerns. It estimates that the U.S. economy lost 23,000 jobs in July and revised down the figures from the prior two months, meaning employers have added just 60,000 workers to their payrolls this summer. 

Yet, despite the decline in workers in July, the unemployment rate ticked down from 4.2% to 4.1% as fewer Americans sought work. 

The picture these latest economic indicators paints of the U.S. economy is a murky one and comes at a pivotal time for monetary policy. What the Fed ends up doing at its next FOMC meeting will largely depend on next week's report on inflation from July as well as employment and inflation readings from August.