. after moving higher in the first half of 2006, core consumer price inflation has also edged lower recently, reflecting a relatively broad - based deceleration in the prices of core goods. that deceleration is probably also due to some extent to lower energy prices, which have reduced costs of production and thereby lessened one source of pressure on the prices of final goods and services. the ebbing of core inflation has likely been promoted as well by the stability of inflation expectations. a waning of the temporary factors that boosted inflation in recent years will probably help foster a continued edging down of core inflation. in particular, futures quotes imply that oil prices are expected to remain well below last year's peak. if actual prices follow the path currently indicated by futures prices, inflation pressures would be reduced further as the benefits of the decline in oil prices from last year's high levels are passed through to a broader range of core goods and services. nonfuel import prices may also put less pressure on core inflation, particularly if price increases for some other commodities, such as metals, slow from last year's rapid rates. but as we have been reminded only too well in recent years, the prices of oil and other commodities are notoriously difficult to predict, and they remain a key source of uncertainty to the inflation outlook. the contribution from rents and shelter costs should also fall back, following a step - up last year. the faster pace of rent increases last year may have been attributable in part to the reduced affordability of owner - occupied housing, which led to a greater demand for rental housing. rents should rise somewhat less quickly this year and next, reflecting recovering demand for owner - occupied housing as well as increases in the supply of rental units, but the extent and pace of that adjustment is not yet clear. upward pressure on inflation could materialize if final demand were to exceed the underlying productive capacity of the economy for a sustained period. the rate of resource utilization is high, as can be seen in rates of capacity utilization above their long - term average and, most evidently, in the tightness of the labor market. indeed, anecdotal reports suggest that businesses are having difficulty recruiting well - qualified workers in certain occupations. measures of labor compensation, though still growing at a moderate pace, have shown some signs of acceleration over the past year, likely in part the result of tight labor market conditions. the implications for inflation of faster growth in nominal labor compensation depend on several factors

. increases in compensation might be offset by higher labor productivity or absorbed by a narrowing of firms'profit margins rather than passed on to consumers in the form of higher prices ; in these circumstances, gains in nominal compensation would translate into gains in real compensation as well. underlying productivity trends appear favorable, and the markup of prices over unit labor costs is high by historical standards, so such an outcome is certainly possible. moreover, if activity expands over the next year or so at the moderate pace anticipated by the fomc, pressures in both labor and product markets should ease modestly. that said, the possibility remains that tightness in product markets could allow firms to pass higher labor costs through to prices, adding to inflation and effectively nullifying the purchasing power of at least some portion of the increase in labor compensation. thus, the high level of resource utilization remains an important upside risk to continued progress on inflation. another significant factor influencing medium - term trends in inflation is the public's expectations of inflation. these expectations have an important bearing on whether transitory influences on prices, such as those created by changes in energy costs, become embedded in wage and price decisions and so leave a lasting imprint on the rate of inflation. it is encouraging that inflation expectations appear to have remained contained. the projections of the members of the board of governors and the presidents of the federal reserve banks are for inflation to continue to ebb over this year and next. in particular, the central tendency of those forecasts is for core inflation – as measured by the price index for personal consumption expenditures excluding food and energy – to be 2 to 2 - 1 / 4 percent this year and to edge lower, to 1 - 3 / 4 to 2 percent, next year. but as i noted earlier, the fomc has continued to view the risk that inflation will not moderate as expected as the predominant policy concern. monetary policy affects spending and inflation with long and variable lags. consequently, policy decisions must be based on an assessment of medium - term economic prospects. at the same time, because economic forecasting is an uncertain enterprise, policymakers must be prepared to respond flexibly to developments in the economy when those developments lead to a re - assessment of the outlook. the dependence of monetary policy actions on a broad range of incoming information complicates the public's attempts to understand and anticipate policy decisions. clear communication by the central bank about the economic outlook, the risks to that outlook, and its monetary policy strategy