US CPI inflation weaker than expected

In this Macro Flash Note, EFG Chief economist Stefan Gerlach looks at the data.

Economic surprises are both positive and negative. In the case of US CPI releases, that is a truth that has been forgotten by many of us. But, at long last, the Bureau of Labor Statistics finally presented some unexpectedly good data on US CPI inflation.

Headline inflation (that is, inflation computed using all the components of the consumer basket) rose 0.2% month-on-month (MoM) and 3.0% year-on-year (YoY) (down from 4.0% in May). Core inflation (inflation excluding the volatile food and energy components) also rose 0.2% MoM and 4.8% YoY (down from 5.3% in May).

To put these data into perspective, the figure below shows the three main components of the CPI measured over 12 months.

The first of these is the component for shelter, which by now is the most important factor pushing up inflation. The cost of shelter depends on the stock of rental contracts – not just those signed in the last month – and therefore moves very sluggishly. However, there is a lot of other information indicating that rents have stopped rising. That means that the contribution of shelter to inflation will be falling in the coming months.

The second component is the core inflation excluding shelter. It is also contributing less and less to overall inflation.

The third group of components is food and energy. While food prices rose 5.7% YoY, energy prices have fallen -16.7% YoY and is pushing overall inflation down.

Chart 1. Inflation over 12 months

Source: Bureau of Labor Statistics and EFG, data as 12 July 2023.

In addition to looking at inflation over 12 months, it is also instructive to look at price changes over a shorter period. The figure below, which illustrates annualised changes over three months, shows that inflation pressures abated sharply last summer. The sluggish component for shelter peaked in the first quarter of this year and has since been declining. Overall, this suggests that inflation measured over 12 months will continue to fall in the coming months as the data from last summer drop out of the calculations.

Chart 2. Inflation over three months (annualised)

Source: Bureau of Labor Statistics and EFG, data as 12 July 2023.

While inflation is an important macroeconomic variable, much of the interest in it arises from its impact on the outlook for US monetary policy. Unfortunately, the Fed will not pay much attention to this single data point and is likely to raise interest rates by another 0.25% at its meeting on 26 July. Central bankers understand that different economic time series are often contradictory, subject to large short-term fluctuations and are frequently revised by large amounts (although that is not the case for the US CPI). They therefore downplay individual data points and instead try to build up a mosaic of the macroeconomic situation using a range of economic data.

However, if, as seems likely, inflation continues to fall it will unavoidably start to influence the Fed’s views of appropriate monetary policy. The Fed is likely to focus on core inflation and would probably want to see at least three consecutive months of marked declines before significantly adjusting their views. By the Fed’s meeting on 20 September, the situation will be much clearer.

Important source information: The sources for data used in this publication are EFG and Refinitiv, as at publication date, unless otherwise stated.

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