Another soft U.S. core Consumer Price Index (CPI) inflation report – the third in a row that has lagged expectations – could complicate the Fed’s intentions to raise rates one more time this year, as the central bank’s Summary of Economic Projections currently forecasts.

May’s inflation weakness was broad-based across goods and services categories (but more pronounced for core goods) and will be more difficult for Fed officials to dismiss as a “one-off.” Core CPI’s weak 0.06% month-over-month advance in May lagged the 0.2% trend and followed a soft advance in April (0.1%) and an outright price decline in March (-0.1%). The March deflation resulted primarily from a large (-7%) one-off adjustment in wireless communication services. However, the weakness in April and now in May isn’t attributable to any single story, and therefore should be more worrying to Fed officials, who were already struggling to meet their inflation target.

Core CPI is now running at 1.7% year-over-year, and we expect core Personal Consumption Expenditures (PCE) to fall another 0.1 percentage point to 1.4% when the May PCE report is released. Although we don’t expect a further deceleration, our year-end forecast for 1.5% continues to be under the 1.7% median projection of Federal Open Market Committee (FOMC) members, and as a result appears more consistent with just two fed funds rate hikes in 2017.

Core goods drop

Core goods prices fell an additional 0.27% month-over-month, and core goods excluding medical care and autos declined 0.4% – the largest one-month decline in this subcategory since the 2008 financial crisis. Household furnishings, apparel, recreational goods, and education and communication all showed declines, and while new and used auto results were also weak, they were in line with recent trends. Wholesale auction prices for used autos tend to lead the CPI by three months, and these prices are deflating 7% year-over-year. The glut of new car leases over the past several years is now weighing on used car prices, and new car inflation is languishing as dealers ramp up incentives amid moderating sales growth.