Bad news for the Fed as inflation and wages continue to rise rapidly

Federal Reserve officials received expected but disheartening news on the economy on Friday as their favorite measure of inflation continued to rise rapidly and a measure of wages and benefits closely tracked by officials continued to rise rapidly.

Policymakers have been quick to raise interest rates this year to try to cool consumer demand and the broader economy in hopes of slowing inflation as inflation lingers near its highest pace in four decades.

So far they see only limited progress. The personal consumption expenditure price index rose 6.2 percent for the year to September, in line with the previous month’s rise. Excluding food and fuel, which can fluctuate month-to-month, prices rose 5.1 percent last year, a steeper rise than the 4.9 percent increase in the year to August.

Both measures of inflation are rising faster than the 2 percent rate that the Fed is targeting on average and over time.

As central bankers try to predict when inflation will slow, they are on the lookout for signs the labor market is loosening and rapid wage growth slowing. It would be difficult for inflation to slow down if wages are rising at the pace they have been recently. Businesses faced with higher labor costs generally try to pass at least some of these cost increases on to consumers.

The employment cost index, a quarterly measure of inflation that tracks changes in wages and benefits, rose 1.2 percent from July to September from the previous three-month period. That was in line with the 1.2 percent increase economists were expecting in a Bloomberg poll. In the last report, the index had risen by 1.3 percent.

This index increase represents 5.0 percent on an annualized basis, only slightly less than 5.1 percent in the previous report and still an unusually fast rate of increase. In the decade before the pandemic, that number averaged 2.2 percent per year, underscoring just how rapid gains are today.

The Fed meets next week and is almost universally expected to announce a three-quarters-of-a-point rate hike on Wednesday. Officials have previously indicated in economic forecasts that they expect rate hikes to slow to a half-point in December, and investors will be watching Fed Chair Jerome H. Powell’s post-meeting press conference closely for signs that that such a move is imminent.

Officials have made it clear that they will eventually stop raising rates, but then plan to leave them at high levels for some time. The idea is that this would continue to weigh on economic growth, slowing the economy and curbing inflation and hopefully avoiding a severe recession.

Friday’s inflation data is unlikely to do much to change central bank views. Officials already knew that inflation continued to run fast over the past month, as the related but more timely CPI rose sharply in September, when it was released in mid-October.

But the new third-quarter payroll data could be at least marginally shaping the thinking of policymakers. Fed officials closely monitor the employment cost index because it avoids some of the data traps affecting other wage measures, including monthly average hourly earnings. These figures tend to move when the composition of the labor force changes: for example, when many low-wage workers leave their jobs, hourly wages can suddenly spike.

Last year, Fed officials specifically cited third-quarter labor cost index data — which was very strong — as a key reason for changing their stance towards a more rapid withdrawal of support from the economy.

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