December CPI: Santa comes early

Summary

Inflation is more firmly on a downward trend. The Consumer Price Index came in lower than expected in November, with the headline rising 0.1% and the core advancing 0.2%. A reversal in energy prices and core goods – particularly vehicle prices—are going a long way toward reducing inflation. Services prices are proving slower to retreat, but here too, there were signs of stretched consumers and fading demand beginning to tamp down pricing power with travel-related services falling across the board.

Nevertheless, a sustained return to the Fed's inflation goal remains some ways away. Services ex-shelter and ex-travel picked up in November, and the overall core index is running at a 4.3% annualized rate the past three months. While the pace of inflation is expected to slow further over the next few months, the roughly 5% pace of wage growth is likely to keep the Fed in inflation-fighting mode for a while yet. We look for the Fed to proceed with its signaled 50 bps hike tomorrow, although the prospect of a further downshift to a 25 bps hike come its first meeting of 2023 has increased with this report.

Consumer prices increase modestly in November

Consumer prices rose just 0.1% in November. Excluding food and energy prices, "core" CPI increased a bit faster at 0.2%, below the Bloomberg consensus of 0.3%. A slide in energy prices for consumers was a major source of deflationary pressure. Gasoline prices declined 2.0% over the month, while energy services prices (electricity and utility gas service) fell 1.1%. Food prices did not outright decline, but the pace of increase did continue to slow. Prices for groceries and food away from home such as restaurants increased 0.5% in November. Although still fast, this marked the smallest increase since December 2021. Gasoline prices have continued to unwind the surge seen earlier this year, and the initial data for December suggests further declines are likely in the near term. With food inflation also showing signs of rolling over, households are finally seeing relief from two of the biggest sources of purchasing power pain.

Time to unwind

The softening trend in inflation was on full display with the core index rising just 0.2%, its smallest increase in 15 months. The unwinding of supply chain kinks and higher inventory levels helped push core goods prices down 0.5%. Used vehicle prices led the way (-2.9%) with new vehicle prices unchanged compared to an average gain of 0.6% the past three months. Recreational and education & communication goods—some of the hottest items of the early days of the pandemic—also saw pronounced price declines.

Lower goods prices are going a long way toward bringing inflation back down, but at only 27% of the core index, the burden of fully quelling inflation lies with services. Core services advanced at a slower pace in November compared to previous months, up 0.4%. The moderation can be traced to a decline in travel-related services. Airfare, hotel and rental car prices all fell over the month in a sign that discretionary spending among consumers is increasingly squeezed and pent-up demand from the pandemic is beginning to fade.

But not all segments of the service sector will be so quick to reprice. Primary rent and owners' equivalent rent inflation picked up on a monthly basis. We expect the downdraft to resume as both the housing and rental market continue to soften under the weight of higher mortgage rates and slower household formation, but the rebound is a reminder that it will take some time for services inflation to settle down. More concerning for the Fed is that our category of "other services" inflation, i.e., services ex-shelter and travel, also picked up in November. We estimate that other services prices rose 0.4% last month compared to 0.2% in October, driven by a pick-up in education & communication services, personal services, and recreation services. This group accounts for 30% of the core CPI and underscores that with labor costs continuing to rise at a strong rate, inflation is unlikely to be resolved in quick order.

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