by Steven Hansen and Doug Short
The Consumer Price Index (CPI-U) annual inflation rate contracted to 3.5% in October 2011 from 3.9% in September. This was above Econintersect’s expectations of 3.2%. Core inflation (CPI less food and energy) grew to 2.1%. 2.0% is the upper boundary of the Federal Reserves target inflation rate.
There has been some hinting at the Fed that inflationary targets may be flexible at this time with so much economic slack.
First, the reasons for the change in the CPI from last month is from the usual suspects – food and oil.
A decline in the energy index more than offset small increases in the indexes for food and all items less food and energy to create the all items decline. The energy index turned down in October after increasing in each of the three previous months as the gasoline and household energy indexes declined after a series of seasonally adjusted increases. The food index rose in October, but posted its smallest increase of the year as the fruits and vegetables index declined sharply.
The index for all items less food and energy increased 0.1 percent in October; this was the same increase as last month and matches its smallest increase of the year. While the shelter and medical care indexes accelerated in October and the apparel index turned up, the indexes for new vehicles, used cars and trucks, airline fare, and recreation all declined.
The all items index has risen 3.5 percent over the last 12 months, a lower figure than last month’s 3.9 percent increase, as the 12-month change in the energy index fell from 19.3 to 14.2 percent. In contrast, the 12-month change for all items less food and energy edged up from 2.0 to 2.1 percent. The food index 12-month change was 4.7 percent, the same figure as in September.
Yesterday, the Producer Price Index for finished goods (analysis here) declined to 5.9% which Econintersect calculated to be indicative of a CPI around 3.2%.
The Briefing.com consensus forecast was for a month-over-month increase of 0.1% – higher than the -0.1% reported by the BLS. Core CPI month-over-month came in at 0.1%, which was the expectation.
The Federal Reserve has argued that energy inflation automatically slows the economy without having to intervene with its monetary policy tools. This is the primary reason the Fed wants to exclude energy from analysis of consumer price increases (the inflation rate).
The next chart is an overlay of Headline CPI and Core CPI (the latter excludes Food and Energy) since 1957. The second chart gives a close-up of the two since 2000.
On the next chart, I’ve highlighted the 1.75% – 2% range, which is generally understood to be the Fed’s target for core inflation. Here we see more easily see the widening spread between headline and core CPI since late 2010, although the headline rate of change has moderated over the past few months and declined in October.
Federal Reserve policy, which focuses on core inflation, and especially the core Personal Consumption Expenditures (PCE), will see that the latest core CPI is beginning to move above the top of the target range; It remains to be seen if there will be a reaction to this in Fed policy.
Caveats on the Use of the Consumer Price Index
Econintersect has performed several tests on this series and finds it fairly representative of price changes (inflation). However, the headline rate is an average – and will not correspond to the price changes seen by any specific person or on a particular subject.
The graph above demonstrates that fuel costs, medical care, and school costs are increasing at a much faster pace than the headline CPI-U – while housing and food costs generally mimic the headline CPI-U.
The Consumer Price Index contains hundreds of sub-indices which should be used to show price changes for a particular subject.
Because of the nuances in determining the month-over-month index values, the year-over-year or annual change in the Consumer Price Index is preferred for comparisons.
Econintersect has analyzed both food and energy showing that food moves synchronously with core. Remember 36% of the CPI is housing based (41% including energy) with 17% food and about 10% of the index is energy related.