Rate hike agenda depends on CPI data

New data showing that wholesale prices posted their largest increase in a year last month have reinforced the view that the Federal Reserve will begin to raise interest rates at its next policy meeting in late June. But the key to whether the Fed will be forced to raise rates at a faster-than-expected pace will be April's consumer price report due out on Friday, economists say.

Early Thursday, the Labor Department said the Producer Price Index, or PPI, which measures prices before they reach store shelves, shot up by 0.7 percent in April, driven by sharply higher prices for energy and food. The "core" rate of inflation, which excludes energy and food prices, rose a more subdued 0.2 percent, matching analysts' expectations.

“There’s not an inflationary storm on the horizon, but there is definitely a cloudy inflationary sky,” said Stuart Hoffman, chief economist at PNC Financial Services Group. “Inflation is becoming a bit of a nuisance after being quite tame and basically a non-factor for the past year or more.”

The strong PPI data raised concerns that the Fed might boost interest rates at its June meeting by more than the quarter percentage point Wall Street had expected.

But while the PPI number suggests that inflationary pressures are beginning to develop in the economy, something the Fed is likely to counteract by starting to push up rates, it is unlikely to lead the Fed to raise interest rates by more than Wall Street expects, some economists said.

Instead, the April consumer price index, or CPI, which measures prices paid by consumers, is likely to have a far greater influence on the Fed's agenda, according to Steve Stanley, an economist at RBS Greenwich Capital. The CPI report is due out at 8:30 am ET on Friday.

“The Fed is exclusively focused on consumer prices, so tomorrow’s number is going to be very important,” said Stanley. Like many other Wall Street analysts, he expects CPI to show a core reading of 0.2 percent, a more modest gain than March’s 0.4 percent, which far outstripped expectations and first raised fears that inflation pressures are building again in the world's largest economy.

“If the CPI number is bigger than we expect, that’s going to be a problem,” Stanley said. “I think we’re locked into a timetable where the Fed’s first rate hike comes in June and the move is a quarter-percentage point, but a strong CPI number could certainly change the pace of the Fed’s rate hikes down the road.”

Earlier this month, the Fed’s policy-setting panel raised its assessment of the risk of inflation but said any moves to raise short-term rates in response would be “measured.”

“If those conditions change, the Fed’s ability to be measured changes,” Stanley said. "If the Fed thinks it’s falling behind the curve it may have to move faster to make sure it catches up with the accelerating economy.”

Still, Stanley says the Fed’s pace of rate hikes over the next year to 18 months is likely to be dictated by the strength of the economic data released from month to month. “The Fed’s going to take it as it comes,” he said.

Scott Anderson, senior economist at Wells Fargo bank, expects CPI to show a fairly stable core inflation rate of 0.1 percent. “But after today’s PPI data, I think the headline number might surprise on the high side,” he added.

Still, Anderson noted he doesn’t think inflation is rising at a troubling rate.

“Core inflation is still seeing a fairly modest increase from month to month, but we’re consistently seeing increases in energy and food prices at faster-than-expected rates,” he said. If the trend continues, it could crimp consumer spending and put the Fed on full alert, he added.

“We’re not going to see this happen this month, but perhaps three to six months down road, so the Fed has to move soon to get ahead of the curve because monetary policy takes up to six months to filter through the system,” said Anderson.

“The Fed doesn’t want to shock the market,” he said. “The last thing they want to do is cut short the recovery, and too sharp an increase in rates has the potential to do that; the Fed just wants to take away a little of the momentum.”