US: Core Inflation Continues Upward Track in April

While the modest gain in headline CPI was of little surprise, the 0.3 percent increase in core CPI was the strongest in nearly four years. Strengthening core inflation gives the Fed confidence in their rate hike plans. 

Modest Headline Inflation at the Start of Q2 

Following energy driven increases that led to back-to-back 0.2 percent gains in February and March, the consumer price index (CPI) rose a more modest 0.1 percent in April. Seasonally adjusted energy prices were slightly lower last month, falling 1.3 percent, with retail gasoline prices declining 1.7 percent. So far in May, retail gasoline prices have risen 6.4 percent, signaling a return of underlying support for May headline CPI. Consumer food price inflation was also soft, recording a flat reading in April after a 0.2 percent decline in March. Prices for food at home fell 0.2 percent, led by the fourth consecutive monthly decline in dairy and related products. Prices for food away from home, which are less susceptible to swings in agriculture prices and are relatively more discretionary, increased 0.2 percent in May and are up 2.9 percent over the past year.

Services Inflation Continues to Underpin Core CPI 

The surprise in today’s report was clearly the 0.3 percent rise in core CPI, the largest monthly gain since August 2011 (out to 2 decimal places). While core goods prices continue to remain depressed due, in part, to the ramifications of a stronger dollar weighing on import costs, core services inflation continues to firm. Core services, which accounts for roughly 60 percent of the headline CPI, increased a strong 0.3 percent in April and has remained steady at a 2.5 percent year-over-year pace over the past year. While shelter costs, the primary driver within services, increased 0.3 percent on the month, strength was also seen in medical care services (0.9 percent, the largest monthly increase since 1990), used cars & trucks (0.6 percent) and household furnishings & operations (0.5 percent). 

Inflation Outlook Gives Fed Scope to Consider Rate Hike

In the April FOMC meeting minutes, most Fed officials expected that while headline inflation will continue to trend well below the 2 percent objective in the near term, inflation would move up to the target over the medium term. We agree with the Fed’s assessment that many of the factors that had held down inflation earlier in the year are transitory and that overall economic improvement, including a tightening labor market, supports expectations for the year-over-year pace of headline inflation to pick up in the second half of the year and into 2016. Today’s CPI report should go a long way toward providing the Fed with reasonable “confidence” that inflation will return to its desired rate over the medium term. Stabilization in energy prices, projections of more limited dollar strength and prospects for higher wage growth will likely color Fed officials’ thoughts on the inflation outlook in the coming months. While we agree that incoming economic data is unlikely to strengthen convincingly enough to entertain a June or July rate hike, a September hike is clearly still on the table, especially if core consumer inflation continues to surprise to the upside.