Vital Signs: Bernanke Vows to Fight Inflation

In the past few days, Federal Reserve Chairman Ben Bernanke has managed to put a new slant on data watching. His suddenly hawkish tone on inflation (BusinessWeek, 6/11/08) has whipsawed Wall Street and left investors scratching their heads wondering if they should be reading economic reports for hints of a coming rate hike instead of another cut.

Only three months ago, the Fed was in hyperdrive saving the economy from a possible meltdown of the financial system. Now, Bernanke is saying the risk of a serious economic downturn has diminished, and the Fed stands ready to “strongly resist” any rise in long-term inflation expectations. On June 11, the futures market was betting heavily on an least one increase in the Fed’s target rate in the second half of the year.

Against that backdrop, this week’s batch of economic reports are not expected to come anywhere close to putting the Fed on a path to higher rates. May housing starts are expected to give back some of their surprise April rise, which was driven by a surge in the small and volatile multifamily sector. April single-family starts fell for the 12th month in a row. The June survey of homebuilders sentiment from the National Association of Home Builders is expected to remain at historical lows. Industrial production, which has been sinking in recent months, is expected to remain weak, perhaps ekeing out a small gain.

Given the Fed’s new attention to inflation, the market will be scrutinizing the May producer price index for signs of rising inflation pressures in the pipeline from raw materials to finished goods. Energy is expected to boost the overall PPI for finished goods, but the core index, which excludes energy and food, is expected to stay tame. Still, core prices in the earlier stages of processing have been accelerating sharply. Yearly core inflation for intermediate goods in April had jumped to 5.8%, from 2.1% six months earlier, and core inflation for crude materials was up to 24.5% from 18.4%. As a result, core inflation for finished goods has been drifting upward over the past year, but that trend is not showing up in core consumer prices.

At some point, the Fed will have to begin lifting rates back to more normal levels that are consistent with its long-run objectives for growth and inflation. The current 2% target rate represents a highly accommodative policy stance. But that normalization will require much firmer economic data during the summer months than most analysts now expect. For now, Bernanke’s sabre rattling appears only indirectly related to inflation control. So far, his hawkish remarks appear aimed at shoring up the dollar, which has had the accompanying effect of pushing down oil prices.

Here’s the weekly economic calendar from Action Economics.

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