Slower CPI Inflation: ’Tis the Season

Slower CPI Inflation: ’Tis the Season

The 15 December Consumer Price Index (CPI) release was more or less in line with expectations, but it did show a moderate deceleration in inflation from recent months: The annualized core inflation rate of 1.7% in the three months through November was down from roughly 2.1% for the three months through October and 2.5% on average in the first quarter of this year.

We’re hesitant to extrapolate too much from the recent deceleration, however, as residual seasonality in core CPI components tends to dampen inflation at this time of year. Heavy discounting during the Thanksgiving holiday shopping weekend and a likely temporary slowdown in recently strong medical price gains probably also contributed.

Season’s readings

Over the past decade, core CPI inflation has typically been higher in the first half of the year before moderating in the second, a tendency that has garnered the attention of Federal Reserve Board staff and persists despite the index being seasonally adjusted. Among the CPI components, durable goods prices tend to follow a pattern similar to that for headline residual seasonality, and shifts in consumption preferences and retail price-setting around the holiday shopping season could be partly to blame.

Ahead of the CPI release, early indications of Thanksgiving weekend sales from retail industry surveys pointed to lower year-over-year sales figures due to heavy discounting. That implied some downward pressure on inflation in core goods categories like apparel, sporting goods, computers and toys, among others. Although these categories have relatively small weights, across-the-board discounts can add up and lower the core inflation figure. The CPI report confirmed weakness in these categories, with core goods prices declining 0.3% since last month on price declines in apparel (-0.5%), household furnishings (-0.4%) and recreation (-0.3%).

Slowing medical care inflation contributed

Separately, medical care inflation also moderated relative to recent trends: After accelerating from a 2.5% year-over-year rate in late-2015 to nearly 5% in August, medical care inflation slowed to 4% in November. We believe the acceleration was largely due to a shift toward insurance plans with lower premiums but higher deductibles, which has meant consumers are shouldering higher out-of-pocket expenses for medical services and prescriptions.

The Affordable Care Act (ACA) was likely the catalyst for some of these trends, and pre-election reports indicated that premiums on health exchanges were set to rise 22% in 2017, suggesting that medical inflation had further to run despite the recent deceleration. And while the U.S. presidential election of Donald Trump has increased uncertainty around the outlook for medical inflation, Trump’s post-election statements indicate that he favors keeping the ACA’s provisions for pre-existing conditions and longer dependent care coverage while eliminating the individual mandate. Taken together, these shifts could increase costs for insurance companies, which would likely be passed on to consumers.

Inflation is still on track

Overall, we think the recent modest deceleration in core inflation is an artifact of residual seasonality, holiday discounting and some deceleration in medical costs that may prove temporary. While these trends could persist in December, we are maintaining our forecast for 2.0%-2.5% core inflation in 2017.

Tiffany Wilding is a PIMCO economist focusing on the U.S. and is a regular contributor to the PIMCO Blog.