Soft Consumer Inflation Backdrop Persists in September

Increases in food and shelter costs helped offset another decline in gasoline prices as headline CPI rose 0.1 percent. Core consumer inflation also held firm and suggests deflation risks are a low probability. 

Rise in Food and Shelter Costs Outweighs Lower Energy Prices

Rebounding from its first monthly decline in 16 months, the headline CPI edged up 0.1 percent in September as increases in food and shelter helped offset a third straight decline in energy prices. The food index rose 0.3 percent last month, maintaining the index’s solid momentum exhibited so far this year. Support in consumer foods was largely driven by another strong gain in meats, poultry, fish & eggs, up 0.7 percent, and dairy & related products, up 0.5 percent–its tenth increase in the past 11 months. Prices for food at home and away from home each rose 0.3 percent on the month and continued to trend higher on a year-ago basis at 3.2 percent and 2.7 percent, respectively, as firms appear to have some pricing power in passing along increased costs to consumers (top chart). Looking ahead, as corn and other grain prices have declined on a glut of supply, food inflation pressures should ease in the coming months. 

Commodity prices in general have fallen significantly over the past few months as global activity has slowed and headwinds from an increased pace of demand have picked up. Indeed, the combination of weaker demand and ample supply has led global crude oil prices to fall by about 25 percent since its recent peak in July. This price cut is showing up at the consumer level as the CPI energy index fell 0.7 percent in September, following declines in August and July, helping boost consumers’ purchasing power. 

Excluding food and energy, consumer prices also rose 0.1 percent following its weaker-than-expected flat reading in August. Shelter costs continue to support core CPI as rent of a primary residence rose 0.3 percent and owners’ equivalent rent increased 0.2 percent. Apparel and new vehicles were flat on the month, but airfare costs continue to descend, down 0.5 percent. 

Near-Term Inflation Outlook Remains Benign

Heading into the October FOMC meeting, Fed officials find themselves observing an economy where its mandates are trending in different directions. On the employment side, the labor market continues to move closer to full employment as hiring averages 200,000-plus a month and the unemployment rate continues to fall. On the price front, however, inflation remains well below its target, reflecting, in part, lower commodity prices and significant growth challenges abroad. Against the backdrop of these growth concerns, worries of deflation threats have cropped back up with inflation expectations turning south. Importantly, expectations still remain in the 5-year channel, albeit at the low end (bottom chart). Lower energy prices will continue to weigh on headline inflation in the near-term, but with core inflation holding firm and prospects of better GDP growth ahead, we believe headline consumer inflation will reverse course and trend back toward the Fed’s longer-run target of 2 percent by year-end 2015.