Inflation is back, but economy remains weak

Luke Sharrett | Bloomberg | Getty Images

A worker loads an aluminum coil onto a loading dock at the Arconic manufacturing facility in Alcoa, Tennessee.

If the Federal Reserve had any doubts about raising interest rates, the government's latest inflation data should help put them to rest.

As Fed policymakers wrapped up their latest two-day meeting, the central bank was widely expected to boost interest rates as the labor market continues to tighten and inflation moves well into their longstanding target range.

Despite the acceleration in price gains, though, the overall strength of the economy remains relatively weak.

Fed policymakers got the latest confirmation that inflation is heating up on Wednesday. The government reported that consumer prices ticked up again last month, pushing the annual rate to 2.7 percent, the biggest year-on-year gain since March 2012.

The consumer price report came a day after the latest reading on producer prices, a measure of the future price increases coming down the pipeline.

The government's producer price index rose faster than expected in February as the rising cost of services pushed the annual gain to 2.2 percent, also the biggest gain in nearly five years, pointing to steadily rising inflation pressures.

"Looking down the road, sharp rises in intermediate goods costs are pointing to further increases in consumer finished goods prices and that doesn't bode well for inflation," said Joel Naroff, chief economist at Naroff Economic Advisors.

For much of the recovery since the Great Recession, the threat of higher inflation has been fairly modest. It wasn't long ago that central bankers around the world were worried that a sustained bout of falling prices could pose a greater threat to global growth.

Inflation remains tame in Europe and Japan, which means central bankers there are unlikely to follow the Fed's lead in pushing interest rates higher. That disconnect in interest-rate policy is one reason for the dollar's ongoing gains against the world's major currencies.

While the Fed's move to higher rates in the U.S. may help tamp down inflation, it also reverses a seven-year economic stimulus that has produced slow but steady growth.

In the past, the Fed has typically sought to use higher rates to cool off inflation and offset future price increases. But Fed Chair Janet Yellen told senators on Capitol Hill last month that uncertainty about the incoming Trump administration's policies has made the central bankers' job more complicated.

"We don't want to base current policy on speculation about what may come down the line. We will wait to gain greater clarity on policy changes," she said.

Those policy changes include a wide range of promises from the Trump administration and GOP-controlled Congress that could have a major impact on the economy, from a major overhaul in taxes to possible new tariffs on imported goods that further increase prices for consumers.

Uncertainty over the prospects for major changes in infrastructure spending and the Affordable Care Act — among other Trump campaign pledges — has complicated matters for the central bankers.

The Fed also faces risks if it waits too long. One of the main forces stoking higher prices is the rebound in oil prices, which fell sharply in 2014 and pulled overall inflation lower.

Now, as oil prices have begun rising again, those higher energy costs have begun working their way through the economy.

Thanks to a pickup in global oil prices, the annual inflation rate in the developed world jumped to 2.3 percent in January 2017, the highest rate since April 2012, according to a recent report from the Organisation for Economic Co-operation and Development, a Paris-based think tank.

Rising prices often accompany faster economic growth. But that's not happening, according to the group's latest global economic outlook.

Although inflation is picking up, the global economy will remain stuck in low gear through next year, according to the OECD's forecast. U.S. GDP growth is expected to hit just 2.8 percent in 2018, down from a November estimate of 3 percent, according to the report.