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U.S. Inflation Rebound Hasn’t Been the Right Kind for This Fed

© Bloomberg. The Marriner S. Eccles Federal Reserve building stands in Washington, D.C., U.S., on Friday, Nov. 18, 2016. Federal Reserve Chair Janet Yellen told lawmakers on Thursday that she intends to stay in the job until her term expires in January 2018 while extolling the virtues of the Fed's independence from political interference.© Bloomberg. The Marriner S. Eccles Federal Reserve building stands in Washington, D.C., U.S., on Friday, Nov. 18, 2016. Federal Reserve Chair Janet Yellen told lawmakers on Thursday that she intends to stay in the job until her term expires in January 2018 while extolling the virtues of the Fed’s independence from political interference.

(Bloomberg) — This isn’t the inflation rebound that Federal Reserve officials were looking for.

While inflation moved closer to the U.S. central bank’s 2 percent target in September and October following months of lackluster results, its increase reflected gains in goods and services that aren’t necessarily linked to monetary policy, according to new Fed research. That means policy makers could still have a hard time reaching their target, which has remained elusive throughout much of the economic recovery.

The Nov. 27 study by San Francisco Fed researchers Tim Mahedy and Adam Shapiro broke down inflation into two categories: procyclical, which responds to changes in the unemployment rate, and acyclical, which does not. It’s the first one that Fed officials care about, as the federal funds rate can have an impact, while the second is more immune to the state of the labor market and, as a result, central bank policy.

And unfortunately for policy makers, an acceleration in acyclical inflation over the last two months has masked further declines in procyclical inflation.

The Fed’s preferred price gauge, which is based on personal consumption expenditures excluding those on food and energy, picked up in September and October to 1.4 percent following declines in six of the seven previous months.

The procyclical inflation measure, which represents 42 percent of the goods and services in the core PCE index, finally rose to the 3 percent level consistent with previous expansions late last year, but has since fallen to 2.4 percent. Meanwhile, the acyclical measure, which represents 58 percent of the core PCE, bounced back to 0.8 percent in October from an almost two-year low of 0.5 percent in August.

The rebound in acyclical inflation reflected the fading effects of Verizon Communications Inc (NYSE:VZ).’s decision earlier this year to change the way it prices cell-phone plans, as well as accelerating airfare prices and motor-vehicle maintenance and repair costs.

The procyclical measure has fallen in large part due to a deceleration in inflation for pharmaceuticals and housing, which includes rentals. Housing in particular should be a concern for the Fed because throughout much of the expansion it had responded more closely than other items to labor-market tightening. The Fed’s hand may be weakened further if rental inflation decouples from the unemployment rate.

Market interest rates have risen over the past three months on increased confidence among investors that the Fed will hike its benchmark overnight rate three times next year, as Jerome Powell takes over leadership of the central bank from Janet Yellen.

That confidence partly reflects the Fed’s conviction that inflation will rebound to 2 percent as the labor market continues to strengthen and transitory effects that weighed prices down this year fade away.

Now, it’s time for the data to play along. The proof will be in the procyclical pudding.

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