Domestic price pressures building

The pick-up in core CPI inflation to a three-and-a-half-year high of 2.2% in January illustrates that rising domestic price pressures won’t allow the Fed to leave interest rates at near-zero levels for that much longer. The 0.3% m/m increase in core prices last month was the biggest monthly gain since August 2011, pushing the three-month annualised rate to 2.5% in the process. This is happening despite the deflationary impact from the stronger dollar, which means that core inflation is going to climb well above the 2% target once the currency stops appreciating. Accordingly, we expect the Fed funds rate to rise to a still modest 1.00% to 1.25% by the end of the year and 2.25% to 2.50% by end-2017.