Another Weak Inflation Report Won’t Help the Fed’s Dilemma

Another Weak Inflation Report Won’t Help the Fed’s Dilemma

Despite a hurricane-related surge in headline inflation, core inflation continued to run softer than expected in September, a trend that could make the Federal Reserve more cautious about hiking interest rates in December.

The Labor Department on Friday reported that core consumer price inflation (CPI), which excludes volatile energy and food prices, advanced 0.13% versus August. That was softer than consensus estimates of 0.2% and August’s 0.25% month-over-month increase. Yet it was in line with the trailing six-month average of 0.12% monthly inflation.

Based on this week’s CPI and Producer Price Index (PPI) releases, we expect core personal consumption expenditures (PCE) inflation (the Federal Reserve’s preferred gauge) to firm to 0.11% in September – keeping the year-over-year rate stable at 1.3%. We continue to forecast core PCE inflation will end the year between 1.3% and 1.4%, below Fed official’s median forecast of 1.5%.

Fed officials have signaled a willingness to continue hiking interest rates despite softer inflationary trends, in light of continued improvements in the labor market and their consensus opinion that inflation expectations are anchored. Still, today’s report may raise fresh doubts about that strategy.

A closer look

Turning to the details of today’s report, in a continuation of recent trends, moderate core services inflation (+0.24%), which is more closely correlated with measures of domestic economic slack, was offset by outright deflation in core goods prices (-0.23%).

Focusing first on core goods, household furnishings (-0.4%) and apparel (-0.1%) both dipped, and various other recreational goods were flat (0.0%). It’s likely a continuation of what appears to be a multi-month adjustment in retail prices probably resulting from increased competition in the retail sector from e-commerce outlets. The prices of prescription and non-prescription drugs were also notably weak as the government reported the largest ever one-month decline in the prices of medical care goods sold in the Midwest region (-3.15%) – a fall unlikely to be repeated. Defying expectations for a hurricane-related boost to auto prices, new (-0.4%) and used (-0.2%) auto price deflation continued.

Turning to core services, September’s core service price inflation moderated somewhat relative to August, but the moderation was expected and we continue to be encouraged by the stabilization in sequential monthly shelter inflation after somewhat more pronounced deceleration in inflation earlier this year. As expected, owners’ equivalent rents (OER) inflation moderated to 0.24% in September versus 0.35% in August, as small sample issues in the Houston area contributed to the largest-ever one-month increase in Houston housing prices (+1.55%) in August – a trend unlikely to continue. Also, as expected, hotel prices (+1.47%) and motor vehicle maintenance and repair prices (+0.6%) were somewhat firmer, likely symptomatic of hurricane-related effects.

Bottom line

The bottom line: Core goods prices continue to deflate in what we believe is a multi-month price-level adjustment that could last through the holiday price-discounting season. Still, looking further out, the continued stability in shelter inflation provides some support for our forecast that CPI inflation should return to 2.0% in late 2018.

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.


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