Bank of the West US Outlook Report Core: Inflation Holds Firm in the Third Quarter

US Outlook Report: Core Inflation Holds Firm in the Third Quarter

In your heart you know there is still inflation out there, no matter what the government or Federal Reserve says. Indeed, the September consumer price index release this week held some interesting information about the future path of inflation.  While the headline CPI continued to drop last month, the core-CPI inflation picked-up and wasn’t as bad as we had been bracing for.

Economic growth headwinds have intensified in recent months and job growth has slowed, but the core inflation outlook remains relatively stable in comparison. We forecast rising consumer inflation, both core and headline inflation, in 2016 as the labor market continues to tighten and oil and energy prices bottom-out.

I think this latest evidence on consumer prices could give some FOMC members more comfort in their consensus view that the decline in U.S. inflation will in fact prove transitory. The prevailing opinion at the Federal Reserve is that as the labor market continues to tighten the inverse relationship between the unemployment rate and inflation, known as the Phillip’s curve, will kick-in.  In other words, lower unemployment rates lead to higher inflation.

Anecdotal evidence seems to be piling up in the Fed’s own Beige Book report for October that the labor market is already tight in many Fed Districts.  The report states that “many Districts were having difficulty finding skilled workers, and, in some cases unskilled workers.  Scattered labor shortages are being reported in construction, trucking, and information technology.

In September, gains in housing, services, food, and education prices helped to push the core-inflation rate up a solid 0.2 percent on the month.  If gains of this magnitude could be sustained over the next twelve months, core-CPI would increase at a robust rate of 2.4%.

But what is the true core inflation rate? It might be higher than you think.  The Federal Reserve Bank of Cleveland publishes some alternative measures of core-CPI inflation that they say provides a better signal of inflation trends than other measures- The Median Consumer Price Index.  This measure of core-inflation is already at 2.5% in September.

Bottom-line, the worst deflation pressure may already be behind us, and the Fed shouldn’t tarry too long before raising interest rates if it is going to fulfill its mandate to promote price stability.

To find out more, check out this week’s US Outlook Report.