U.S. core Consumer Price Index (CPI) inflation lagged expectations in August, breaking from the recent trend of generally upward surprises from various wage and price reports.
Core CPI advanced 0.08% month over month, well under consensus expectations for a 0.2% rise, and the year-over-year rate ticked down to 2.2% (from 2.4% in July). The slower CPI reading follows positive revisions to unit labor cost inflation and an acceleration in average hourly earnings – and raises questions about the extent to which faster nominal wage inflation, which has been accompanied by faster productivity growth over the past year, will result in higher consumer price inflation.
Yesterday's report also confirms various Federal Open Market Committee (FOMC) participants’ assertions that broader inflationary forces are manageable despite the historically low unemployment rate, and reinforces our view that a gradual pace of rate hikes remains appropriate for now.
Broad retail declines weigh down core CPI
Core CPI inflation (which excludes food and energy prices) was weighed down by the largest monthly drop in core retail goods (-0.5%) for this economic cycle, outside of the year-end holiday sales period (which has witnessed steeper discounting in recent years). Declines were broad-based but particularly notable in apparel, TVs and other electronics, sporting goods and toys.
Over the past several years, prices in these segments have generally declined amid higher competition from e-commerce retailers, including Amazon. Prices appeared to firm somewhat over the first half of the year, likely the result of rising input prices and the lagged effects of 2017 U.S. dollar depreciation across currencies in Asian countries, including China, that supply goods to the U.S. However, more recently the dollar has strengthened. While the lag for currency movements to spill over into consumer prices is generally thought to be around six to 12 months, it’s possible that currency-related price cuts are happening more quickly. While the August weakness could also be a one-off occurrence, we are keeping an eye on this trend.
Medical goods and services dip
Medical goods and services prices also dropped in August, with notable declines in prices of medical equipment and supplies and non-prescription drugs. Industry reports indicate that Amazon’s 2015 entry into the business-to-business market for medical supplies has intensified competition in that segment and is resulting in mark-up compression similar to that in the retail sector.
Vehicle inflation cools
New and used vehicle inflation cooled after surging over the past three months on what appeared to be higher pass-through rates for rising steel and aluminum prices. The threat of the Trump administration levying higher tariffs on imported autos and trucks, which has now subsided somewhat, may have also contributed to the earlier price hikes. Notably, auto purchases have fallen in the three months since the price hikes, and consumer demand sensitivity to auto prices appears to be somewhat greater than during earlier post-crisis periods. This trend reaffirms our view, discussed in our July CPI note, that price sensitivity will likely limit the extent to which auto dealers can pass on rising input prices.
Shelter holds firm as airfare accelerates
Prices across other services categories also moderated in August, but key categories, including shelter, remained firm. Rents, owners’ equivalent rents and the more volatile hotels category all rose. Shelter inflation in large cities remained moderate, likely due to higher multifamily housing supply in large cities and a drop in Houston housing prices after a hurricane-related price jump in the first half of 2018. However, firmer shelter price trends elsewhere offset the impact. Lastly, airfare inflation accelerated to 2.4% month over month amid higher jet fuel prices.
Bottom line? The downside CPI surprise raises questions about the extent to which faster wage and input price inflation will result in higher consumer price inflation. The slower reading may also reinforce the FOMC view that inflation remains manageable and may continue to support a gradual pace of rate hikes.
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.