Americans' inflation expectations dropped again in August, New York Fed says

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Consumer expectations for where inflation will be one year from now fell again in August, according to a key Federal Reserve Bank of New York survey published Monday, a potentially reassuring sign for the U.S. central bank as it tries to cool surging prices. 

The median expectation is that the inflation rate will be up 5.7% one year from now, a marked decline from 6.2% recorded in June, according to the New York Federal Reserve's Survey of Consumer Expectations. Three years from now, consumers see inflation cooling off slightly to 2.8% – down from the 3.2% recorded last month. 

Consumers anticipate that prices will drop even further over the next five years, projecting that the inflation rate will hover around 2% in 2027.

"Median inflation uncertainty—or the uncertainty expressed regarding future inflation outcomes—decreased at the short-term horizon and was unchanged at the medium-term horizon," the survey said. 

INFLATION NOW CAUSING FINANCIAL PAIN FOR MOST AMERICANS, SURVEY SHOWS

Shoppers walk through the milk and cream section of a supermarket in Montebello, California, on August 23, 2022. ((Photo by FREDERIC J. BROWN/AFP via Getty Images) / Getty Images)

The report is based on a rotating panel of 1,300 households.

The survey plays a critical role in determining how Fed policymakers respond to the inflation crisis. That is because actual inflation depends, at least in part, on what consumers think it will be. It is sort of a self-fulfilling prophecy – if everyone expects prices to rise by 3% in the year, that signals to businesses that they can increase prices by at least 3%. Workers, in turn, will want a 3% pay raise to offset the rising costs. 

A steeper-than-expected increase in inflation expectations in May actually prompted Fed officials to approve the first 75-basis-point interest rate hike since 1994 on fears that higher prices were becoming entrenched. 

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In explaining the Fed's decision during a post-meeting press conference, Chairman Jerome Powell said policymakers were looking for evidence that monthly inflation was flattening or starting to fall. With consumer prices repeatedly surprising to the upside and inflation expectations unexpectedly climbing higher, officials determined that "strong action was warranted," he said.

"One of the factors in our deciding to move ahead with 75 basis points today was what we saw in inflation expectations," Powell told reporters during a press conference after the meeting. "We're absolutely determined to keep them anchored at 2%. That was one of the reasons – the other was just the CPI reading."

Jerome Powell, chairman of the U.S. Federal Reserve, speaks during a news conference following a Federal Open Market Committee meeting in Washington, D.C., on Wednesday, May 4, 2022.  (Photographer: Al Drago/Bloomberg via Getty Images / Getty Images)

Policymakers approved another 75-basis-point hike in July and have indicated in recent weeks that another increase of that magnitude is on the table in September as they rush to catch up with runaway inflation. Powell has warned that tackling inflation with higher interest rates could have "painful" consequences for households and businesses nationwide, likely in the form of higher unemployment. 

"While higher interest rates, slower growth and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses," he said at the Fed's annual economic symposium in Wyoming. "These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain."

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The new inflation expectation projections come just a few days before the release of new consumer price index data, which is expected to be another doozy: Economists surveyed by Refinitiv expect that inflation rose 8.0% in August on an annual basis; while that is down from June's high of 9.1% and below July's reading of 8.5%, it remains well above pre-pandemic levels.

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