Core CPI May Tick Up Before Moderating in the Second Half

The decline in oil prices continues to weigh on headline Consumer Price Index (CPI) inflation, which fell 0.3 percentage point to 1.6% year-over-year in January. However, core CPI (which excludes energy and food prices) held steady at 2.2% year-over-year, with support from normalization in retail prices after holiday discounting late last year.

We expect core CPI to pick up somewhat further in the next few months as rising input costs from the various import tariffs continue to support prices, before moderating to 2.1% in the second half of the year. We view the still-modest inflationary pressures as supportive of the Federal Reserve’s recent pivot toward a more patient and cautious approach to further rate hikes.

Retail goods rebound

January’s stronger price gains were concentrated in core retail goods, as is typical for this time of year. Seasonal factors have not fully caught up to the evolution in the holiday discounting cycle – i.e., more consumption shifting into the earlier part of the fourth quarter as retailers, including e-commerce, use promotions to get a jump start on the holidays. This has resulted in weaker retail goods inflation in November and December, followed by a reversal in January and February. Consistent with these patterns, prices across various retail goods categories were stronger in the January print. Most notably, apparel, household furnishings, and various electronics were all firmer month-over-month in January, offsetting weaker prints late last year.

Tariffs create noise

Inflation on goods subject to the 10% tariffs on Chinese imports still appeared noisy after surging for many of these categories in December. Sporting goods and sewing machines, for example, appear to have normalized, with modest declines in January after outsize price gains the prior month, but gains in other categories, like toys, were still strong. Despite the noise, we expect some further modest pass-through of the tariffs to consumer prices in the next few months.

Meanwhile, new car prices rose solidly for the first time in six months, likely driven by higher input prices, including increases arising from the steel tariffs. At the same time, used car prices stabilized at 0.1% month-over-month after volatile swings in this category late last year following a CPI methodology change.

Elsewhere, core services inflation remained stable. Owners’ equivalent rents (OER) firmed somewhat from last month, but the year-over-year rate was stable at 3.2%, where it has remained for the better part of the past two years.

Bottom line? We believe tariffs will support a limited acceleration in core CPI in the coming months before moderating to 2.1% in the second half of 2019. The still-modest inflationary pressures offer support for the Fed’s more patient approach to rate hikes.

For more of PIMCO’s views on the complex drivers of inflation in the U.S. and globally, please visit our inflation page.

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Tiffany Wilding

North American Economist

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