ORLANDO, Florida, March 19 (Reuters) - Keeping inflation

expectations under control is arguably a central bank's most

important job. But it is also one of the most challenging given

that the picture painted by the surveys, models and market

prices relied on by policymakers is, at best, unclear, and at

worst, so muddled as to be barely useful at all.

That's especially true today, and one more reason why the

Federal Reserve is proceeding with caution.

Consumer expectations can, understandably, be volatile. The

layperson is unlikely to have a firm grasp on how global supply

chains, commodity prices or monetary policy lags affect prices.

They could therefore easily be influenced - or spooked - by news

headlines and current conditions. Survey responses are thus

often based more on emotion than economic analysis.

This helps explain why the five-year inflation outlook in

the University of Michigan's latest survey of consumers jumped

to 3.9% in February. That's the highest since 1993, and was

undoubtedly driven by legitimate fears about the impact U.S.

President Donald Trump's tariffs could have on prices.

Yet the New York Fed's February survey tells a very

different story. It shows that the U.S. public's five-year

inflation horizon was unchanged from January at 3.0%. Indeed,

this report's five-year outlook has been stuck in a 2.5-3.0%

range for more than two years.

If that's not confusing enough, financial markets' long-term

inflation outlook suggests there's no need to worry at all.

Five-year/five-year forward breakevens, a measure of

expected inflation over a five-year period starting in five

years' time, have been trending lower in recent weeks and were

last trading around 2.1%. That's the lowest in two years,

significantly below current annual CPI inflation of 2.8%, and

practically at the Fed's 2% target.

This suggests investors believe tariff shocks will pass, the

Fed will keep policy sufficiently tight to get inflation down,

or growth will be weak. Or some combination of all three.

TENUOUS LINK

Given that consumer expectations, particularly over the

shorter one-year and three-year horizons, are more volatile than

market-based measures, how should policymakers make sense of

these conflicting signals?

A Cleveland Fed paper from October 2021 suggests they should

be taken with a grain of salt. It found that the predictive

relationship of a range of inflation expectation gauges was hit

and miss. And much more miss than hit.

Researchers found that consumers are particularly bad at

predicting inflation. Again, this may be no real surprise given

that people without a financial background often struggle to

distinguish between the price level and the rate of price

increases.

Though, for what it's worth, the Cleveland Fed researchers

found that financial markets' predictive power isn't that much

better.

Another 2021 paper by Fed staffer Jeremy Rudd went further,

warning that the relationship between expected and actual

inflation "has no compelling theoretical or empirical basis and

could potentially result in serious policy errors."

That's a troubling conclusion given the importance

policymakers put on keeping inflation expectations anchored.

But Fed Chair Jerome Powell doesn't seem worried. Speaking

to reporters on Wednesday after Fed officials cut their GDP

growth projections but raised the inflation outlook, he insisted

that long-term expectations remain well-contained even if

short-term ones are rising.

The recent University of Michigan survey was an "outlier",

but will still be factored into policymakers' thinking along

with all the other indicators they look at.

"We monitor inflation expectations very, very carefully,

every source we can find. We do not take anything for granted,"

Powell said, adding that anchored inflation expectations are at

"the very heart of our framework."

(The opinions expressed here are those of the author, a

columnist for Reuters.)

(By Jamie McGeever;)