Overall inflation likely coming down: Fed's Mishkin

MONTREAL (Reuters) - Rising energy prices over the last five years raise risks of higher inflation expectations, but the underlying trend of inflation does not appear to be higher, Federal Reserve Governor Frederic Mishkin said on Saturday.

Inflation will tend to rise with higher energy prices; but once energy prices settle at a higher level, overall inflation will return to a lower rate, closer to inflation excluding food and energy prices, referred to as "core" inflation.

"As long as the permanent change in relative energy prices does not lead to a change in the underlying trend rate of inflation -- a crucial assumption -- then headline inflation will come back down again," he said in remarks prepared for delivery at a conference on monetary policy in Montreal.

"This is what we seem to have seen recently in the United States," he added, citing a drop in a favorite inflation measure of the Fed, the personal consumption expenditures (PCE) price index.

Central bankers prefer, when measuring inflation, to exclude food and energy prices, which can be volatile, and focus instead on core prices, he said.

"What central bankers are truly concerned with ... is the underlying rate of inflation going forward, and core inflation can be a useful proxy for that rate," he said. "Thus, focusing on core inflation can help prevent a central bank from responding too strongly to transitory movements in inflation."

Policy-makers also need to pay attention to the broader inflation picture -- "headline" inflation -- because, if overall inflation remains higher than core inflation for a long period of time, the public will build higher inflation into its expectations, Mishkin said.

Since 2002, "the effect of energy price shocks have been more persistent," he said. Headline inflation has been a half-percentage point higher than core inflation on average during this period he said.

Over the past year, energy prices have leveled off on balance, bringing the broader measure of inflation closer to core measures, Mishkin said.

Even so, the recent increase in oil prices raises concerns, he said.

"The increases in oil prices in recent days provide another reminder that shocks can persist longer than one might have expected," he said.

U.S. crude oil reached a record high $90.07 a barrel on Friday before settling lower. U.S. oil has rallied more than 15 percent since October 8.

Meanwhile, the pickup in energy prices helped drive up the U.S. Labor Department's consumer price index at the sharpest rate in four months in September, a report released this week showed.

The Fed is weighing lingering worries about inflation with growing concerns about economic weakness due to a prolonged housing slump and tighter credit conditions after a spike in mortgage delinquencies.

The U.S. central bank aggressively cut benchmark borrowing costs by a half-percentage point to 4.75 percent at its September policy meeting.

Stocks took a big slide on Friday, and markets now rate the chances of another quarter point cut at the Fed's October 30-31 policy meeting as practically certain, as implied by federal funds futures.