Pressing on the Gas, Consumer Prices Rise in February

Released from the depressing effects of lower gasoline prices, headline inflation increased for the first time in four months in February. Core inflation remains firm and supportive of a Fed rate hike later this year

Broad-Based Gains Support Consumer Inflation

For the first time in four months, the headline Consumer Price Index (CPI) increased, rising 0.2 percent in February. This brought the year-over-year rate back out of negative territory, at least temporarily. Although broadbased increases were seen throughout the report, the 2.4 percent rise in gasoline prices garnered the most market attention, given that it represents the first monthly increase since June 2014 and the largest monthly gain since December 2013. Looking ahead, retail gasoline prices have been flat so far in March and should be fairly neutral to headline price changes when we receive next month’s report.

Following no change in January, consumer food prices increased 0.2 percent in February as prices for both food at home and away from home increased. Year over year, food prices are up a solid 3.0 percent. Excluding food and energy, consumer prices remain firm. Rising a touch more than expected, the core CPI increased a moderate 0.2 percent in February, which lifted the year-over-year rate to 1.7 percent from 1.6 percent in January. As seen from the middle chart, increases in core services prices continue to more than offset declines from core goods prices, which have been negatively impacted by the strengthening U.S. dollar. Within services, shelter costs dominate the price action, as twothirds of February’s core CPI gain was attributed to this component thanks to ongoing improvement in the labor market boosting demand for housing. Elsewhere, price increases were seen in new and used motor vehicles, airline fares and apparel. Medical services slipped 0.2 percent, the first decline since 1975.

Core Inflation Trajectory Key for Monetary Policy

Lastweek, the Fed significantly downgraded inflation forecasts for 2015 with Chair Yellen stating the FOMC would raise rates once it has seen “further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.” While further declines are quite possible in the near term, we expect headline consumer inflation to begin firming on a year-over-year basis in the second half of the year and into 2016. Indeed, getting to 2 percent on headline CPI in 2016 will not take great effort as long as the recovery continues as projected given the current low headline inflation. Core inflation will be closely watched by the Fed for any signs of change in the underlying trend given the outsized impact from sharply lower energy prices on the headline base (for policy purposes, the Fed prefers the PCE deflator). As evidenced in today’s report, core inflation remains firm and we expect it to continue to exhibit signs of strength and, therefore, provide policy makers with the confidence needed to hike interest rates in the second half of the year.