US: High Headline Inflation, Contained Core
US: High Headline Inflation, Contained Core
Overview: The consumer price data for May confirmed that higher energy prices continue to boost overall inflation while the core component remains contained. Headline inflation jumped to 0.6% m/m from 0.2% m/m in April and is now running at 4.2% y/y. Core inflation posted an ‘average’ 0.2% m/m reading, which kept the year-over-year rate steady at 2.3%.
Details: Food prices were relatively calm in May increasing only by 0.3% m/m and 5.1 % y/y. Hence, the headline inflation was primarily boosted by a 4.4% m/m surge in energy prices, which is now up by 17.4% y/y. It is worth to note that the revised seasonal factors have been suppressing the seasonally adjusted energy price index significantly over the past three months. Since February the new seasonal factors have removed around 9pp from the level of energy prices compared to only 3pp in the old procedure (see chart below). In June the seasonal factor will remove another 0.5pp from energy inflation, but from then on we will enter a ‘payback period’. Hence, even with stable energy prices the energy index will be boosted by 10pp over the July-December period. This is likely to deliver an average contribution of around 0.15pp to monthly headline inflation throughout H2.
Core inflation has been relatively moderate lately. Over the past three months core prices are up by 1.8% AR and on a year-to-date basis by 2.0% AR. Still this is probably somewhat below the underlying trend which we believe is in the range 2.25 to 2.50%. Temporary factors such as lower apparel, lodging and car prices seem to have held down the core for most of the year so far. That said, that general impression remains that there is little, if any, pass through from increasing inflation expectations or higher energy and food prices.
Assessment & Outlook: Going forward, we expect annual core inflation to move sideways close to the current level of 2.3% y/y, as lagged effects from rising raw material prices and a weaker currency will be countered by lower wage pressures. We do not see any meaningful slowdown in core inflation before somewhere in 2009. Annual headline inflation is set to move somewhat higher peaking close to 5.0% in August.
Elsewhere it will be important to watch inflation expectations, as this is likely to be a key determinant for central bank language going forward. Today Michigan 5-year inflation expectations showed an unchanged reading at 3.4%. While it is good news that the index did not drift higher, it certainly remains at an uncomfortably high level. As we have emphasised in earlier comments this week, we do not expect the Federal Reserve to hike interest rates anytime soon. However, the one factor that could potentially change this view is if inflation expectations continue to move up further and remain very elevated for a prolonged time (see this week’s edition of Weekly Focus for a more thorough discussion of this topic).
Danske Bank
http://www.danskebank.com/danskeresearch
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