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Focus Shifts Away From Traditional Inflation Gauge

Fixed-income economists are increasingly relying on the Personal Consumption Expenditures Price Index (PCE) instead of the more traditional Consumer Price Index (CPI) to measure inflation.

Fixed-income economists are increasingly relying on the Personal Consumption Expenditures Price Index (PCE) instead of the more traditional Consumer Price Index (CPI) to measure inflation. They said the shift allows for bond market watchers to gauge a more accurate view of inflation and follows the lead of the Federal Reserve, which in its most recent semi-annual report began referencing the core PCE.

The PCE is perceived as being more nimble in keeping up with changes in consumer spending habits because the weight given to certain goods in the index is changed quarterly to better reflect spending patterns, versus once every two years for the CPI. The PCE uses some of the same data as the CPI but it also relies on monthly retail sales.

Still, there is some reluctance among veteran traders to adopt the Fed's new way of thinking, according to William Prophet, interest-rate strategist at UBS. "Old habits die hard," he said, noting while economists are increasingly using the more reliable method, traders have been slower to make the switch.

Regardless of which indicator it looks at, the Fed will likely take the view inflation is increasing. James O'Sullivan, U.S. economist at UBS, predicted both measures will rise through 2005 reflecting solid economic growth. Current levels of 1.7% for the CPI and 1.5% for the PCE are considered pretty "tame." He said he expects CPI to rise to 2.5% from 1.7% and the PCE to rise to 2.2% from 1.5% by the end of next year.

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