The Inflation Update

This morning's BLS release is a mixed bag. The all items Consumer Price Index rose an extremely modest 0.6% at an annual rate (a.r.). Even the traditional core inflation index, the CPI excluding food and energy, showed an unexceptional 1.8% (a.r.) increase from January to February. But there are contradictory signals in the report, and they start with the alternative core measure, the Median CPI computed by the Federal Reserve Bank of Cleveland. The Median CPI was up 3.5% (a.r.), its highest monthly increase in 4 years. Overall, the data confirm the view that the CPI inflation trend is still around 2.5%. But, is it rising?

To see, we turn to the details. Core goods prices (commodities excluding food and energy commodities) fell at a -1.7% annual rate for the month, and are unchanged for the past 12 months. But when we move to service prices, the good news ends. Core services prices (services excluding energy services) rose 4.1% (a.r.) in February, well above their recent trend.

Moving deeper, let's take a look at two of the components where I tend to focus more attention: food away from home and owner equivalent rent. Restaurants increased their prices at a 3.7% annual rate (seasonally adjusted) in February; and owner equivalent rent rose by the same amount. Both of these are well above recent trends of 2.5% to 3%.

Even so, the inflation trend is likely to remain around 2.5% so long as OER inflation doesn't pick up. But for every percentage point increase in rental inflation above 3.5% (the current OER trend), the inflation trend will go up about 0.3%. And there is a risk that OER inflation could slowly rise and stay at levels above 4%. We will need to keep an eye on that over the next few months.

Turning to the policy implications of this morning's new data, the inflation hawks have a case to make, but it seems strained and is surely premature. My guess is that FOMC discussions will focus on the downside risks to real growth, not on the upside risks to inflation. With the housing market cooling off, it is hard to see 4% consumption growth continuing. And investment spending seems unlikely to take up the slack. The trick for Chairman Bernanke and his colleagues is going to be to try to keep inflation from increasing at the same time that they ensure growth doesn't slow too much. That's why I'm sticking to the view expressed in my mid-December 2005 update that, unless something unforeseen happens, the FOMC will raise their federal funds rate target to 5%, and no further.

Consumer Price Inflation, Various Measures
(Through February 2006, 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:
www.brandeis.edu/~cecchett

Detail for Computation of the Median CPI
February 2006
Component	1-month annualized percent change	Relative importance (Normalized)	Cumulative relative importance
Fuel oil and other fuels	-28.6	0.3	0.3
Jewelry and watches	-17.1	0.3	0.7
Gas (piped) and electricity	-14.7	4.3	4.9
Women's and girls' apparel	-14.3	1.6	6.5
Men's and boys' apparel	-11.8	0.9	7.4
Motor fuel	-10.0	4.3	11.8
Footwear	-8.3	0.8	12.5
Motor vehicle insurance	-3.9	2.3	14.9
Cereals and bakery products	-3.9	1.1	16.0
Meats, poultry, fish, and eggs	-3.2	2.1	18.1
Public transportation	-2.6	1.1	19.2
Nonalcoholic beverages and beverage materials	-2.4	0.9	20.1
Dairy and related products	-1.9	0.9	21.0
Personal care products	-1.5	0.7	21.7
Other food at home	-1.4	1.8	23.5
Household furnishings and operations	0.0	4.8	28.2
Motor vehicle fees	0.0	0.5	28.7
Communication	0.0	3.1	31.8
New vehicles	0.9	5.2	37.0
Recreation	1.1	5.7	42.7
Miscellaneous personal goods	1.4	0.2	42.9
Miscellaneous personal services	1.6	1.2	44.0
Used cars and trucks	1.7	1.8	45.8
Tobacco and smoking products	1.9	0.7	46.6
Education	3.1	3.0	49.6
Tenants' and household insurance	3.2	0.4	49.9
Medical care commodities	3.5	1.5	51.4
Owners' equivalent rent of primary residence	3.7	23.6	75.0
Food away from home	3.7	6.0	81.0
Rent of primary residence	3.9	5.9	86.9
Motor vehicle parts and equipment	5.4	0.4	87.2
Medical care services	6.5	4.8	92.0
Processed fruits and vegetables	7.1	0.3	92.3
Lodging away from home	7.4	2.6	94.9
Car and truck rental	8.0	0.1	95.0
Fresh fruits and vegetables	8.8	1.0	96.0
Personal care services	9.1	0.7	96.7
Alcoholic beverages	9.5	1.1	97.8
Water and sewer and trash collection services	10.3	0.9	98.7
Motor vehicle maintenance and repair	11.4	1.1	99.8
Infants' and toddlers' apparel	23.0	0.2	100.0

Previous	All Items CPI	CPI ex Food & Energy	Median CPI	16% Trimmed Mean
1 Month	0.6	1.8	3.5	1.4
3 Months	2.7	2.0	2.9	2.4
6 Months	3.0	2.3	2.7	2.7
12 Months	3.6	2.1	2.5	2.5
12 Months ended February 2005	3.0	2.4	2.2	2.2

Detail for Computation of the Median CPI