Increasing consumer anxiety that prices are broadly on the rise should not trigger an inflation-fighting response from the U.S. Federal Reserve, according to research Monday from the San Francisco Fed.
That's because consumers are not particularly good at forecasting inflation, according to the research, published in the regional Fed bank's latest Economic Letter. Households tend to make their worst guesses about future inflation when fuel and food prices spike, as they have in recent months.
Policy-makers watch inflation expectations closely, because when people expect prices to rise they often change their behavior in such a way as to make those expectations a self-fulfilling prophecy.
But the research suggested they are probably safe to ignore at least one widely followed survey's gauge of household inflation fears. It compared inflation forecasts from the Thomson Reuters/University of Michigan's consumer sentiment survey against actual inflation over the last eight years.
Recent data from the survey shows households now expect inflation to average about 4.5 percent over the next 12 months, a big jump from last year's expectation of 3 percent.
The increase is likely due to the sharp rise in food and energy prices to which households are particularly sensitive, San Francisco Fed research advisor Bharat Trehan said.
Households in the survey overpredicted inflation by an average of 1.1 percentage points in the last five years, when commodities prices have been particularly volatile, Trehan showed.
Consumer inflation expectations also rose in 2008, when energy prices similarly spiked, but actual inflation ended up falling, not rising.
Households appear to be reacting to recent inflation data in a way that is not warranted by the actual dynamics of inflation, Trehan said in the paper. The poor forecasting performance argues against reacting strongly to the recent increases in household inflation expectations.
Data released a week and a half ago showed U.S. consumer prices rose to a 2-1/2-year high of 3.2 percent in the 12 months to April.
The pace of food and fuel price rises slowed from the month before, however, suggesting inflation pressures may be peaking.
Most Fed officials expect commodities price rises to be short-lived, a view born out by a drop this month in oil prices. San Francisco Fed President John Williams earlier this month said he believes inflation will begin falling by mid-year, sinking back to well below the Fed's unofficial 2 percent target by next year.
Primary dealers polled by Reuters last week see the consumer price index rising by 3 percent in the fourth quarter.
(Reporting by Ann Saphir)