Falling Commodity Prices to Weigh on Near-Term Inflation

A myriad of factors have sent commodity prices broadly lower over the past month. The drop in input prices for raw materials will weigh on near-term headline inflation but should have little impact on the core. 

Slower Demand Growth, Rising Supply and a Stronger Dollar

Commodity prices have tumbled in recent weeks as concerns over slow global growth and over-supplied markets have mounted. In addition, the resumption of the upward trend in the greenback has weighed on dollardenominated prices.

For many commodity types, the recent decline represents a continuation of the trend that has been in place over the past year (top chart). The Bloomberg industrial metals index has fallen about 25 percent over the past 12 months as growth in China—the largest consumer of metals—has continued to slow and supply remains strong as new capacity investments made during the recent boom years have come on line (middle chart).

WTI oil has dropped about 20 percent over the past month following reports of still-elevated inventories and a likely deal with Iran that would further boost global supply later this year. Prices for many agricultural commodities have also given back some ground in recent weeks. While corn prices are up slightly, prices for soybeans, wheat coffee, sugar and cocoa are all down over the past month as well as the past year. Livestock prices are also moving lower. With the outlook brightening for future herd sizes, what seemed to be an unrelenting climb in cattle prices has turned around, and hog prices are down nearly 40 percent from last year’s high levels that were induced by a virus outbreak. All in all, the CRB commodity index has fallen nearly 18 percent since its most recent peak in May of last year.

Renewed Pressure on Headline Inflation

The recent drop in commodity prices will likely renew downward pressure on consumer price inflation. The past few months’ readings on inflation had showed price trends firming. The CPI and PCE deflator have both picked up over the past three months, in part due to the spring rebound in oil prices, but also an uptrend in core prices. While this past month’s decline in oil prices looks in some ways tame compared to the seven-month slide that began last June, the breadth of decline among other commodities suggests the CPI is likely to head a bit lower in the near term. We find that a 10 percent drop in the CRB index, if sustained, would shave 0.4 percentage points off the year-over-year rate of CPI inflation.

Of course, Fed officials tend to focus on core inflation in the short term as changes in commodity prices can be volatile and more symptomatic of temporary supply issues rather than underlying demand trends. While the recent drop in commodity prices looks to be in part influenced by scaled back expectations for demand in the coming year, the effect on core inflation is likely to be only modest. Our estimates show a 10 percent drop in the CRB index would lower the year-over-year rate of core inflation by less than 0.1 percentage point.