The Inflation Update

The all-items CPI rose 8.2% at an annual rate (a.r.) for the first month of 2006, and is up 4.0% for the past 12 months. While these numbers are very large, their recent monthly volatility makes them nearly impossible to interpret. Instead, we can look at various gauges of core inflation, and here there is cause for concern. The traditional CPI excluding food and energy rose 2.4% (a.r.) in January while the Median CPI computed by the Federal Reserve Bank of Cleveland increased at a 2.5% annual rate. For the past 12 months, the CPI ex. food & energy is up 2.1%, while the Median CPI rose 2.6%.

The detail in this morning's report is somewhat more ominous. First, there is the fact that owner equivalent rent rose 2.6% (a.r.) for the month, very close to its 12-month trend. Then there is the fact that food away from home, which tends to be a solid indicator of the overall inflation trend, was up 3.7% (a.r.) in January. And finally, there is the 2.6% (a.r.) increase in service prices. All of this suggests that inflation is on the verge of rising above its 2.5% trend. (The data mavens in the crowd will notice that the 16% trimmed mean has risen suddenly as well!)

The implications of this for monetary policy are clear. In his testimony last week Chairman Bernanke made clear that he believes price stability is the basis for high growth; a view that is almost surely shared by the bulk of his FOMC colleagues. With inflation at 2.5% and rising, this means at least one and possibly two more interest rate increase is in the offing.

Consumer Price Inflation, Various Measures
(Through January 2005, all data s.a. at an annual rate)

For previous updates, as well as my occasional essays on current policy issues,
Please visit my home page:
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Detail for Computation of the Median CPI
January 2006
Component	1-month annualized percent change	Relative importance (Normalized)	Cumulative relative importance
Car and truck rental	-30.9	0.1	0.1
Fuel oil and other fuels	-13.6	0.3	0.4
Women's and girls' apparel	-7.4	1.6	2.0
Household furnishings and operations	-3.7	4.8	6.9
Tenants' and household insurance	-2.0	0.4	7.2
Miscellaneous personal goods	-1.4	0.2	7.4
Personal care services	-1.2	0.7	8.1
Motor vehicle insurance	0.0	2.3	10.5
Recreation	0.0	5.7	16.1
Medical care services	0.4	4.8	21.0
Meats, poultry, fish, and eggs	0.6	2.2	23.1
Used cars and trucks	0.9	1.8	24.9
Rent of primary residence	1.6	5.9	30.8
Infants' and toddlers' apparel	2.1	0.2	31.0
Men's and boys' apparel	2.1	0.9	31.9
Motor vehicle maintenance and repair	2.3	1.1	33.1
Owners' equivalent rent of primary residence	2.6	23.7	56.8
Communication	2.9	3.1	59.9
Personal care products	3.1	0.7	60.6
Nonalcoholic beverages and beverage materials	3.3	0.9	61.5
Miscellaneous personal services	3.6	1.2	62.7
Food away from home	3.7	6.0	68.7
Motor vehicle parts and equipment	4.3	0.4	69.1
Tobacco and smoking products	4.8	0.7	69.8
Medical care commodities	5.2	1.5	71.3
Lodging away from home	5.6	2.7	73.9
Dairy and related products	6.1	0.9	74.8
Cereals and bakery products	6.5	1.1	75.9
Other food at home	6.6	1.8	77.7
New vehicles	7.2	5.2	82.9
Water and sewer and trash collection services	8.4	0.9	83.7
Education	8.8	3.0	86.8
Jewelry and watches	8.8	0.3	87.1
Alcoholic beverages	10.2	1.1	88.2
Processed fruits and vegetables	16.0	0.3	88.4
Public transportation	16.2	1.1	89.5
Motor vehicle fees	20.2	0.5	90.0
Footwear	28.7	0.8	90.8
Fresh fruits and vegetables	33.4	1.0	91.8
Gas (piped) and electricity	64.4	4.1	95.9
Motor fuel	106.6	4.1	100.0

Previous	All Items CPI	CPI ex Food & Energy	Median CPI	16% Trimmed Mean
1 Month	8.2	2.4	2.6	4.2
3 Months	-0.2	2.4	2.7	2.8
6 Months	4.0	2.2	2.5	2.8
12 Months	4.0	2.1	2.5	2.6
12 Months ended December 2005	3.0	2.3	2.3	2.3

Detail for Computation of the Median CPI