While broadly in line with expectations, last Friday’s consumer price index (CPI) report affirms our view that inflation remains on an upward trend. Pimco projects year-over-year core CPI will finish 2015 at 2.10%, considerably stronger than consensus expectations at the start of the year, and well above 2014’s rate of 1.61%.
However, the drivers of inflation may begin to change over the cyclical horizon. For example, shelter inflation has driven much of the recent strength in core CPI. In June, both rent and owner’s equivalent rent, which combine to make up around 40% of core CPI, increased by 0.4% month-over-month. Shelter inflation should remain strong, but it may be tempered a bit over the medium run by increasing housing supply, a trend underscored by today’s strong housing starts and building permits data.
Weakness in Friday’s report came in core goods (-0.1% month-over-month) and medical care services (-0.2%). Going forward, however, we expect some of the pressure on core goods inflation to abate, as the U.S. dollar and oil prices have been roughly flat since March. We also expect wages to rise over the coming year, which should result in more broad-based services inflation beyond the shelter component.
One wrinkle in the report is that the weakness in medical care inflation means that core personal consumption expenditure (PCE) data should remain soft relative to core CPI data, since the PCE measure places greater weight on medical inflation. Nonetheless, core PCE should still likely finish the year above the Fed’s 1.30% to 1.40% projection for 2015 if our forecasts prove correct.
(Source: PIMCO, WSJ)