Will Inflation Preclude a September Liftoff?

Inflation Chartbook: August 2015 

Persistently weak inflation has been the biggest impediment to the Fed’s plan to begin normalizing monetary policy this year, in our view. Inflation has risen over the spring and early summer but is still not where policymakers would like it to be. The personal consumption expenditure (PCE) deflator has risen at a 2.4 percent annualized rate over the past three months, while the CPI has similarly strengthened, up at a 3.5 percent clip over that period. The pickup across both measures of consumer price inflation suggests that the dismal year-ago readings of inflation should at least continue to move back toward the Fed’s target. 

Recent gains in headline inflation, however, are in jeopardy over the near term. Commodity prices have tumbled across the board in recent weeks, with declines in energy, industrial metals, crops and livestock. The breadth of declines can be tied to renewed jitters over the slowdown in the Chinese economy, which has been a major source of new demand for raw materials over the past decade. In addition, after little change between March and June, the dollar has resumed its upward trend. The broad trade-weighted dollar index has risen 2.6 percent over the past month, as the Greek debt crisis and Chinese stock market turmoil reaffirmed the prospect of U.S. monetary policy soon diverging from the rest of the world. After a steady run in May and June, oil prices have fallen more than 20 percent since the end of June, while the CRB metals index has fallen to the lowest level since 2010. 

The effects of changing commodity prices on final consumer inflation tend to show up almost immediately.1 As such, the 3.7 percent drop in the CRB index will likely lead to soft prints in July’s inflation figures. We find that a 10 percent drop in the CRB index, if sustained, would slice off  0.4 percentage points from the year-over-year rate of inflation. The effect on core inflation, however, will be more modest and should not upset the recent firming trend. While still below desired levels, the core PCE deflator increased at a 1.7 percent annualized clip over Q2. Core CPI inflation has also continued to run at strong pace relative to recent years, up at a 2.3 percent pace in the past three months amid further gains in shelter, transportation and medical care costs.