* Key U.S. inflation gauge slows to 3-1/2 year low
* Decline hardens views Fed to keep buying bonds
* Fed to maintain $85 bln bond buying pace this week
By Alister Bull
WASHINGTON, April 29 A slowdown in a key measure
of U.S. inflation in March will encourage Federal Reserve
officials to keep aggressively buying bonds for most of 2013 and
dim any enthusiasm for an early tapering of the program.
The U.S. central bank wants to drive down high unemployment
while keeping inflation near its 2 percent target. Data released
on Monday showed prices were heading in the wrong direction.
The Fed's favored gauge of consumer prices - the personal
consumption expenditures price index - fell to 1.0 percent
year-on-year in March from 1.3 percent in February. It was the
smallest gain in 3-1/2 years.
"This is another force pushing toward the Fed continuing on,
with no tapering (of bond purchases) this year," said Dean Maki,
chief U.S. economist at Barclays Capital in New York.
On the other hand, it will take evidence of weaker growth
and a softer labor market spilling into more widespread
expectations for lower prices to prompt the Fed to seriously
consider increasing the scale of bond purchases, he said.
The Fed is currently buying $85 billion of longer-dated U.S.
Treasuries and mortgage-backed bonds every month. It is expected
to vote to keep doing so at the conclusion of a two-day
policy-setting meeting on Wednesday. A statement announcing the
decision is scheduled for release at 2 p.m. (1800 GMT).
Commodity prices have slipped in recent weeks, with gold
falling sharply and Brent oil prices also down some 13 percent
from a February peak around $119 a barrel.
The Fed tries to look past short-term swings in energy and
food prices. Instead, it focuses on trends in so-called core
inflation, which excludes these often-volatile prices.
But the core PCE price index has also been dropping. In
March, it dipped to 1.1 percent - the lowest in 2 years - from
1.3 percent in February.
"Core PCE inflation briefly hit the Fed's 2.0 percent target
in March 2012 for the first time since 2008, but it has fallen
by almost a point now in the past year after a substantial
slowing since mid-2012," said Ted Wieseman at Morgan Stanley.
"Along with the sluggish outlook for second quarter growth,
the increasing miss on the inflation side of the Fed's dual
mandate we believe has removed the risk of an early start to QE
INFLATION EXPECTATIONS STABLE
At the Fed's last meeting in late March, some officials
voiced confidence that improving U.S. economic growth might
warrant a tapering in the pace of bond buying in coming months,
according to minutes of the meeting.
But a weak March employment report released earlier this
month, plus other softer signals from the economy, appeared to
make that less likely. The dip in prices cements that view.
"Both core and headline inflation are now about 100 basis
points (1 percentage point) below the Fed's 2 percent long-term
goal," Michael Darda, chief economist at MKM Partners LLC, wrote
in a note to clients.
"With unemployment still about 200 basis points above what
the Fed believes is its long-term sustainable level, previous
talk of Fed tapering should die down even if the macro data
The unemployment rate was 7.6 percent in March and Fed
officials think they could get it down to the 5.2 percent to 6
percent range before wage pressures increase enough to threaten
a rise in inflation.
The Fed specifically targets 2 percent inflation as measured
by the PCE price index and not the more popular Consumer Price
Index. The CPI stood at 1.5 percent year-over-year in March,
while core CPI was up 1.9 percent from a year ago.
The difference might matter to policymakers because Treasury
Inflation Protected Securities, or TIPS, which the Fed uses to
weigh expectations for future inflation, are calculated using
The Fed will seek confirmation that lower inflation as
measured by the PCE price index is getting baked into
expectations for lower prices generally, before giving credence
to the risk of a damaging deflationary trend that would warrant
raising the pace of bond buying.
This is not yet happening. The break-even spread for the
10-year TIPS, which measures the difference in yield between the
TIPS and a normal Treasury note, was 2.35 percent in Monday
afternoon trading, little changed from late last week.