As many observers expected, after five months of surprisingly soft inflation prints, prices firmed in August. U.S. core CPI inflation (which excludes the volatile food and energy categories) was up 0.25%, boosted by the largest-ever one-month increase in hotel prices and surprising firmness in rents and owners’ equivalent rents (OER).
Overall, the August print bolsters our outlook for a return to 2% CPI inflation in 2018. Still, despite the recent firming, we continue to expect core personal consumption expenditures (PCE) inflation (the Federal Reserve’s preferred gauge) to end 2017 below the most recent median Federal Open Market Committee (FOMC) projection of 1.7%.
Hotel prices and rents provide a boost
Turning to the details of the report, a record-high one-month increase in hotel prices (+4.38%) – following the largest-ever drop (-4.2%) last month – was a big contributor to the CPI gains. The midweek timing of the Fourth of July holiday this year, along with the rise in peer-to-peer lodging, likely exacerbated recent volatility.
At the same time, rents (+0.39%) and OER (+0.35%) firmed further following disinflationary trends in the first half of the year, turning in the largest one-month advances since the 2008 financial crisis.
Because the rent categories tend to have the tightest correlations with measures of economic slack, today’s report was likely a relief to Fed officials after several months of soft prints raised questions about the traditional link between economic slack and inflation.
Core goods trend down again
Turning to core goods, prices continued to deflate in August, in line with recent trends.
New and used auto prices ticked down month-over-month as the industry continues to work through a supply glut resulting from heightened leasing activity and waning new car demand. While demand related to damage from the recent hurricanes could help reduce supply a bit faster than previously expected, we wouldn’t want to overstate the potential boost, given that businesses have reportedly delayed normal fleet updates as they wait for used car prices to firm.
Meanwhile, core goods excluding autos and medical were also soft (-0.15%) on declines in prices of various retail goods. Rising competition from e-commerce to traditional retailers is contributing to an ongoing price-level adjustment that will likely persist through year-end. In particular, we’ve observed an amplification in seasonal pricing patterns around the holidays as brick-and-mortar retailers use heavy discounts to drive traffic to stores.
Bottom line? The strengthening in CPI (particularly in the rent categories) is likely good news to the Fed – and makes a return to 2% CPI inflation in 2018 look more probable.
For more of PIMCO’s views on the complex drivers of inflation in the U.S. and globally, please visit our inflation page.
Tiffany Wilding is a PIMCO economist focusing on the U.S. and is a regular contributor to the PIMCO Blog.