Despite the sharp rebound in core inflation this year, there seems to be a growing belief in the markets that the Fed is now prepared to allow inflation to rise above the 2% target without stepping up the pace of rate hikes. After all, the FOMC has recently stressed the “symmetric” nature of that target, while some Fed officials apparently believe that a modest overshoot of 2% would be desirable.
In our view, however, the Fed is simply acknowledging that, at 1.8% in April, core PCE inflation is now close to the target, and that officials aren’t going to slam on the brakes if it hits 2%. But if we’re right in expecting core PCE inflation to rise above 2% over the coming months, there is a good chance that the FOMC will respond by raising interest rates three more times in 2018, starting at the next meeting in two weeks’ time.
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