U.S. core Consumer Price Index (CPI) inflation advanced just 0.12% month-over-month in September, the softest reading since November 2017, dragged down by the largest monthly drop in used car inflation since 2003 and soft shelter readings. While other categories were largely in line with expectations, we believe the September report is further evidence that inflationary pressures are broadly manageable, despite higher business input costs, amid some acceleration in productivity growth. The report does not change our view that the Federal Reserve is likely to continue on a gradual pace of rate increases, with three more hikes likely between now and the end of 2019.
The year-over-year rate of core inflation remained steady at 2.2%. Looking ahead, we expect tariff actions to help boost core CPI to 2.5% year-over-year by mid-2019 before settling back to 2.2% by year-end, though the impact of factors including currency adjustment and import substitution could change our view.
Behind the used car price dip
Used car prices were noisy in September, and we take little signal from the large reported drop in the price index. The Bureau of Labor Statistics (BLS) noted that a confluence of factors, including the yearly quality adjustment procedure and a recent methodology change in the used car price index, contributed to the 3% drop for the category in September. Wholesale used car auction data from industry sources, including Manheim and the National Automobile Dealers Association (NADA), were firmer, leading us to maintain our previous forecast for roughly flat auto inflation over the next year after meaningful deflation in 2017.
We believe rising input prices, including tariff-related increases for steel and aluminum, will likely limit outright deflation for autos, but note that higher consumer sensitivity to prices is limiting manufacturers’ ability to fully pass on the higher costs. Indeed, over the past several months, volume declines accompanied the increase in auto prices, while Wards reported better-than-expected volumes in September, coinciding with the price drop.
We view softness in the highly weighted shelter components as somewhat more concerning. While one should not overemphasize a single data print, the 0.18% month-over-month increase in owners’ equivalent rents (OER) was the slowest since December 2014, and the more volatile rental category was also on the soft side (+0.24%). Slower inflation outside of large cities contributed to the moderation in September, following moderating trends in large cities that have weighed on the broader category for the past several months.
Retail bounces back
As expected, retail goods prices rebounded in September (+0.23%), led by apparel. The BLS noted that small sample sizes for retail apparel price quotes, particularly in the Southern U.S., contributed to recent swings.
Smoothing through the noise, we expect deflationary pressure from the U.S. dollar’s 10% appreciation against the Chinese yuan since April will likely offset some (but not all) of the price impact of additional tariffs. The late-September United States Trade Representative (USTR) announcement that it would phase in 25% tariffs on an additional $200 billion of Chinese imports included some consumer goods, such as chairs, small appliances, bags and personal care products. We estimate that these products account for around 3.5% of the CPI basket and could raise the year-over-year pace of CPI by 0.2 percentage points annualized over the next three months (when tariffs levied will increase by 10 percentage points) and another 0.2 percentage points after 1 January 2019, when the full 25% tariff increases are levied.
We think the softer-than-expected September CPI print – while likely affected by statistical noise – offers evidence that inflationary pressures remain broadly manageable. We continue to forecast core CPI will accelerate to a peak of 2.5% year-over-year by mid-2019, temporarily boosted by the various tariff actions, before settling back to 2.2% by the end of 2019. However, we will be watching the level of currency adjustment and import substitution, among other factors, which could change our outlook.
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.