Core U.S. Consumer Price Index (CPI) inflation rebounded in October, though not as much as expected, driven largely by a bounce in used car prices. The year-over-year rate ticked down to 2.1%, and evidence of tariff-related price increases was mixed.
The October print is consistent with stable core inflation (which excludes energy and food prices), as a cyclical rise in productivity appears to be buffering the extent to which rising labor and non-labor input costs are being passed on to consumers. Looking at the CPI and recent Producer Price Index (PPI) figures, we estimate that core personal consumption expenditure (PCE) inflation – the Federal Reserve’s preferred measure – could dip to 1.8% year-over-year in October (from 2.0% in September). These data, along with the recent labor market report, reflect “Goldilocks” conditions (not too hot, not too cold) in the U.S. economy, where solid growth in labor market demand has been met with capacity improvement and still-manageable inflationary pressures. Overall, the data, coupled with our forecast for a moderation in real GDP growth over the next several quarters, support our current forecast for three Federal Reserve rate hikes between now and the end of 2019.
Mixed early results for tariffs
October’s bump in used car prices followed a methodological quirk in the used car series in September that resulted in the single largest monthly price drop (−3.0%) since 2003. October’s 2.6% advance for the category partly offset the loss, and drove much of the rebound in today’s inflation print.
Outside of used cars, core goods inflation was softer, however, and evidence was mixed that the recent Chinese import duty hikes are affecting consumer price inflation. Among the products listed by the United States Trade Representative (USTR) as eligible for the late-September 10% increase in customs duties, prices firmed for small appliances, furniture, and clocks and lamps but were soft for other items, including sports vehicles and bikes, pet products and personal care products.
We continue to expect a portion of the tariff hikes to be passed on to U.S. consumers. While policy measures in China to keep production costs low – including announced most favored nation (MFN) reductions, yuan depreciation and import substitution – will likely mute the price pressures somewhat, keep in mind that tariffs are scheduled to increase to the full 25% on 1 January 2019. And while media reports suggest that negotiations between the U.S. and China could avert the scheduled tariff increase, we are skeptical that a deal will be reached.
On the surface, trade policies have so far had little noticeable impact on the U.S. economy, which could embolden the Trump administration to stay the course, at least for now. Furthermore, the positive growth impulse from government spending will continue to support the economy for the next few quarters, and the U.S. administration’s concerns with China extend further than trade, to defense and foreign policy. So while we continue to view the likelihood of an all-out trade war as low, we believe tensions are likely to remain high for the foreseeable future.
Core services soften, while shelter holds firm
Meanwhile, core services inflation was softer than expected (+0.17% month-over-month), dragged down by a large price drop in the volatile hotels category, along with flat airfares.
The stable shelter categories, including rents and owners’ equivalent rent (OER), were firmer. Digging into the OER data, shelter inflation in large cities continued to moderate after accelerating earlier this year, and is now running at a 3.4% year-over-year pace. OER inflation in smaller cities and rural areas has remained stable at around 3.2% month-over-month.
Bottom line? We view the October print as broadly consistent with core CPI inflation ending 2019 around 2.1% after accelerating up to 2.4% by midyear, although the early evidence suggests that pass-through of tariff-related price increases could be muted.
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.