May 2012 CPI Continues to Moderate, Core Inflation Again Unchanged

by Steven Hansen and Doug Short

The May 2012 Consumer Price Index (CPI-U) annual inflation rate fell from 2.3% to 1.7%. Core inflation (CPI less food and energy) was unchanged again at 2.3% annual inflation.

The Producer Price Index (released yesterday) are showing that intermediate and crude goods are deflating pointing to continued moderation of the CPI in months to come.

Inflation generally accelerates as the economy heats up – and a lower inflation rate could be an indicator that the economy is cooling.  However, inflation does not correlate well to the economy – and cannot be used as a economic indicator.

First, the major inflation issue in month-over-month CPI from remains moderate upward pressure from food,  but the obvious big item was used cars.

The Consumer Price Index for All Urban Consumers (CPI-U) decreased 0.3 percent in May on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 1.7 percent before seasonal adjustment.

The gasoline index declined 6.8 percent in May, leading to a sharp decrease in the energy index and the decline in the all items index. The indexes for natural gas and fuel oil declined as well, though the electricity index increased. The food index was unchanged, with a slight decline in the index for food at home offsetting an increase in the food away from home index.

The index for all items less food and energy rose 0.2 percent in May, the third consecutive such increase. The indexes contributing to the increase were largely the same ones as in April: shelter, medical care, used cars and trucks, apparel, airline fares, and new vehicles. The indexes for household furnishings and operations and for tobacco declined.

The 12-month change in the index for all items was 1.7 percent in May; this figure has been declining steadily since its 3.9 percent recent peak in September 2011. The decline has been driven mostly by the energy index, which decreased 3.9 percent over the last 12 months. This was its first 12-month decline since October 2009. The 12-month change in the food index, which was 4.7 percent as recently  December, fell to 2.8 percent in May. The 12-month change in the index for all items less food and energy was 2.3 percent in May, the same figure as in April and March.

On the other hand, historically, the CPI-U general index tends to correlate over time with the CPI-U’s food index. This puts an upward pressure on the CPI. These forces are in conflict. (chart below to be changed out when FRED updates).

Notice the gap in the above graphic between the CPI and Food – historically this gap has always closed when the knock-on effect from higher food prices into other CPI components moderates.

The market expected month-over-month CPI-U growth at -0.2 to -0.3% (versus -0.3% actual), with the core inflation expectations at 0.1% (versus 0.2% actual).

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).

Detailed Analysis

The Bureau of Labor Statistics released the CPI data for last month this morning. Year-over-year Headline CPI came in at 1.70%, down dramatically from 2.30% last month. Year-over year-Core CPI came in at 2.26%, which the BLS rounds to 2.3%, down fractionally from 2.31% last month.

The first 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 2% level, 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, a pattern that began changing last October as headline inflation declined while core continued to rise, although it has lately started flattening out.

Federal Reserve policy, which focuses on core inflation, and especially the core Personal Consumption Expenditures (PCE), will see that the latest core CPI is fractionally above the target range, even though the more volatile headline inflation has fallen below two percent.

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.

Although the CPI represents the costs of some mythical person. Each of us need to provide a multiplier to the BLS numbers to make this index representative of our individual situation. This mythical person envisioned spending pattern would be approximately:

The average Joe Sixpack budgets to spend his entire paycheck or retirement income – so even small changes have a large impact to a budget.

The graph above demonstrates that fuel costs, medical care, and school costs are increasing at a much faster pace than 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.

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