Rising energy, food costs test Fed core inflation focus

By Mark Felsenthal - Analysis

WASHINGTON (Reuters) - Swiftly rising food and energy costs are challenging the Federal Reserve's practice of focusing heavily on core prices in setting monetary policy, but the central bank shows little sign of changing its thinking.

The Fed's focus on inflation gauges that strip out food and energy prices stems from the belief that these core measures are less volatile and provide the clearest picture of where inflation is heading.

"If inflation expectations are well anchored, changes in energy -- and food -- prices should have relatively little influence on 'core' inflation," Federal Reserve Chairman Ben Bernanke said on Tuesday in an endorsement of the Fed's long-standing reliance on these core gauges.

"One might think of this effort to distinguish transitory from persistent price changes as a more nuanced way of estimating the underlying inflation trend," he said.

But some analysts believe the Fed may be taking too narrow a focus, since some measurements show headline inflation persistently higher than the core yardstick.

"These are the prices that consumers are paying, and they have not been moderating. They have been reaccelerating. So it looks like the core is giving what looks like an increasingly misleading signal about trends," said Julia Coronado, a former Fed economist now with Barclays Capital in New York.

Energy and food account for about a quarter of the U.S. Labor Department's consumer price index -- the nation's most popular inflation gauge. Historically, these costs have been more volatile than prices for the other 75 percent of goods and services that comprise the CPI "basket."

However, food and energy prices have been increasing more quickly than core prices for a number of months, and especially in the case of energy, for much longer.