July 2012 CPI Shows Offsetting Inflationary Dynamics

by Steven Hansen and Doug Short

The July 2012 Consumer Price Index (CPI-U) annual inflation rate contracted from 1.7% to 1.4. Core inflation (CPI less food and energy) eased slightly from 2.2% to 2.1% annual inflation.

The dynamics are energy and food price components were mixed – and overall offsetting.  This is why the month-over-month change was zero.

The Producer Price Index (released yesterday) are showing that intermediate and crude goods are continuing to deflate –  but the knock-on effects into the CPI will be mitigated by a new round of food and energy inflation.

Percent Change Year-over-Year – Comparing PPI Finished Goods (blue line) to PPI Crude Materials (red line)

As a generalization – inflation accelerates as the economy heats up, while inflation rate falling 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) was unchanged in July on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 1.4 percent before seasonal adjustment.

Major indexes posted small movements in July, with a 0.3 percent decline in the energy index offsetting 0.1 percent increases in the indexes for food and all items less food and energy. Within energy, declines in the indexes for electricity, natural gas, and fuel oil more than offset a small increase in the gasoline index. Within the food component, the food at home index was unchanged with major grocery store food group indexes mixed, while the food away from home index increased.

The index for all items less food and energy rose 0.1 percent in July, ending a streak of four consecutive 0.2 percent increases. The shelter index rose 0.1 percent for the second month in a row. The indexes for medical care, tobacco, household furnishings and operations, and apparel also increased, while the indexes for airline fares, used cars and trucks, recreation, and new vehicles all declined.

The 12-month change in the index for all items was 1.4 percent in July. This compares to 1.7 percent in June and is the smallest 12-month change since November 2010. The index for all items less food and energy rose 2.1 percent for the 12 months ending July, a slight decline from the 2.2 percent figure in June and its smallest increase since October 2011.

Historically, the CPI-U general index tends to correlate over time with the CPI-U’s food index. The current situation is putting an upward pressure on the CPI countering the downward pressure on the CPI by the Producer Price Index.

CPI-U Index compared to the Food sub-Index of CPI-U

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% (versus ___% actual), with the core inflation expectations at 0.2% (versus ___% 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).

/images/z cpi1.png

And one look at the different price changes seen by the BEA in this PCE release versus the BEA’s GDP and BLS’s Consumer Price Index (CPI).

Year-over-Year Change – PCE’s Price Index (blue line) versus CPI-U (red line) versus GDP Deflator (green line)

Detailed Analysis

The Bureau of Labor Statistics released the CPI data for July this morning. Year-over-year unadjusted Headline CPI came in at 1.41%, which the BLS rounds to 1.4%, down from 1.66% last month (1.7% in the BLS record). Year-over year-Core CPI (ex Food and Energy) came in at 2.10%, down fractionally from 2.22%% (rounded to 2.2%) 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 flattened out in 2012.

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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