No Single Culprit for April’s Weak U.S. CPI

The U.S. core Consumer Price Index (CPI) recorded another soft print in April, at 0.07% month-over-month, following very weak results in March (-0.122%). But unlike in March – when weakness was primarily attributable to the largest-ever monthly decline in wireless services – April’s weakness was broad-based, reflecting softness in a range of core goods and services. As a result, we’ve reduced our 2017 year-end core U.S. inflation forecast to 2.0% from 2.3%. Negative residual seasonality, which tends to be a drag in the latter half of the year, may be a headwind to our forecast and could further moderate the rate for fourth-quarter 2017 relative to the same quarter last year.

The noticeable softening in inflation increases the pressure on Federal Reserve policymakers to explain their presumed plan to hike interest rates in June. While still-easy financial conditions and a 4.4% unemployment rate could help the Fed craft a coherent story for June, continued weak inflation could complicate further hikes later this year. Based on this report and the latest Producer Price Index (PPI), we calculate that the year-over-year rate of personal consumption expenditure (PCE) inflation could fall to 1.4% in April from 1.6% in March, and we now believe it will be closer to 1.5% at the end of fiscal 2017. This compares with the Federal Open Market Committee (FOMC) median projection of 1.9%.

No single smoking gun, though core goods disappoint

Both new and used auto prices declined further in April after falling last month, in what appears to be the start of a more meaningful trend. Industry reports indicate that an increase in vehicle leases over the past several years has created a glut of used autos. This is pressuring wholesale used-car auction prices, which tend to lead the CPI by around three months.

Other core goods were also soft in April, with recreational goods, furnishings and apparel showing declines. China consumer goods price trends and the exchange rate can have a meaningful impact on these prices. However, despite an acceleration in the China PPI last year, a closer look reveals that price pressures were concentrated in industrial metals, which are unlikely to affect the U.S. CPI (although they will likely influence U.S. PPI and import prices). Finally, medical goods prices fell in April on the largest-ever decline in prescription drugs prices, likely due to major drugs going off patent.

Core services languish

Core services inflation was also below trend in April, at +0.14%, after a 0.06% drop in March resulting from the plunge in wireless services. Rents (+0.3%) and owner’s equivalent rent (OER) inflation (+0.23%) were consistent with our forecasts for some modest deceleration. Rents in the largest 10 cities continue to moderate in line with the glut of multifamily housing supply, but outside those cities, low inventory of affordable housing continues to support a firmer 3.5% year-over-year pace of rental inflation. Meanwhile, medical service prices were weak in April due to the largest-ever decline in physicians’ services, and transportation services, recreation services and education were all flat to down.

In a nutshell, unlike in March, April’s soft inflation across a range of core goods and services prices cannot be explained away by large, one-off price adjustments or other quirks in the data. We’ve revised our U.S. inflation forecast accordingly.

Tiffany Wilding is a PIMCO economist focusing on the U.S. and is a regular contributor to the PIMCO Blog.



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