Continued Weak Core CPI to Test the Fed

A growing number of Federal Open Market Committee officials have voiced concerns over decelerating inflation since the June FOMC meeting, and the latest inflation print likely did little to alleviate them. U.S. core Consumer Price Index (CPI) inflation ticked up to 0.12% month-over-month in June, but was again weaker than consensus expectations as prices fell across a number of core goods. After today’s CPI print, we forecast core personal consumption expenditure (PCE) inflation will advance 0.09% in June and likely end the year at 1.5% year-over-year, below the FOMC’s median forecast of 1.7%.

Core goods weakness: not a one-off

Turning to the details of today’s report, core goods fell 0.1% in June in what is starting to look like a more pronounced deflationary trend, after declines of 0.3% in May and 0.2% in April. Not surprisingly, some of the weakness stemmed from further decreases in new and used auto prices amid pressure from oversupply.

More disappointing was the 0.1% drop for other core goods after the 0.4% decline in May, one of the weakest months since the 2008 financial crisis. Linens, apparel and various appliances and electronics, which drove the weakness in May, can suffer from one-off months of heavy discounting. However, the follow-on weakness in June fuels arguments that e-commerce-related disruptions in the retail industry are weighing more broadly on the prices of various goods.

Core services, shelter advance

On a firmer note, core service inflation advanced 0.2%, in line with our forecast for a rebound. Notably, shelter inflation – including rents (+0.4%) and owners’ equivalent rent (+0.3) – was somewhat stronger than in recent months, which could indicate that the disinflationary impact of a glut of multifamily housing in large cities has run its course. Meanwhile, medical inflation, including medical commodities and services, was also firmer than we were expecting, boosted by large advances in medicinal (+0.7%) and prescription (+1.0%) drugs, as well as hospital and related services (+0.8%).

Bottom line?

June marked the fourth month in a row that core CPI inflation has printed under consensus forecasts, bringing down the year-over-year core inflation rate to 1.7% versus the 2.3% peak in February. This disappointing result raises questions about the likelihood of another Federal Reserve interest rate hike this year. At the same time, the stabilization in shelter inflation after several months of pronounced softening supports our forecast that CPI inflation should return to 2.0% in 2018.

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



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