Inflation – What’s Hot, What’s Not - February 25, 2019

The Federal Reserve is on hold right now regarding interest rates. How long it remains on hold will depend primarily on the economy. But one thing that has given the Fed some wiggle room has been lower-than-expected inflation.

When it comes to inflation, one’s purchases will largely influence one’s perception. The cost of health care, your bill for cable TV, season football tickets, or the price to book your latest vacation might leave you scratching your head when you hear inflation is low.

However, investors, bondholders, economists, market analysts and policy makers at the Fed closely follow broad-based indexes when determining whether or not inflation is a problem.

One such gauge is the Consumer Price Index (CPI). Thanks to the recent drop in gasoline prices, the CPI was up just 1.6% in January versus a year ago (U.S. BLS). That’s down from 2.9% in August.

If we break the CPI into key categories, we can get a better idea what is influencing inflation.

The graphic below carves the CPI into three major categories: Services, goods, and goods excluding food and energy.

The rate of increase in prices of services, which includes things like rent, medical care, and recreation, has outpaced the broad index for much of the period surveyed. Still, it has hovered in a fairly stable range and isn’t showing signs of accelerating.

The price of goods is heavily influenced by what happens to energy. As highlighted below, we see a sharp decline in 2015, when oil prices collapsed. Prices have recently fallen thanks to the latest drop in oil.

For much of the period surveyed, prices for retail goods less food and energy were falling. That has changed. Price hikes remain muted but we’re no longer in deflationary territory. A February 10th Wall Street Journal article entitled, Prepare to Pay More for Diapers, Clorox and Cat Litter—Big brands plan further price increases for household staples after finding some success doing so last year, illustrates the trend.

Higher raw material costs are playing a role, and the long-running economic expansion may be whittling down resistance to price hikes. Whether or not consumers will accept another round of price increases or switch to generic brands remains to be seen, but we are seeing minor inflation where deflation had been the rule.

From the vantage point of monetary policy, it’s very unlikely a little bit of inflation in retail goods will encourage the Fed to resume rate hikes any time soon.