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October 18, 2006
Headline CPI down, core up
A couple of dynamics seem to be at work in the CPI numbers released today. Obviously the fall in gas prices decreased the headline number which was down by 0.5%. That was no surprise. Yet the core rate continues to come in above the Fed's comfort zone. This months increase in the core was at 0.2%, the same as last months increase. Combined with previous increases, the core CPI has increased by 2.9% from a year ago.
Owners equivalent rent (OER) continues to push the core upward. This is due to two factors--the improvement in the rental market as housing slows, and the fall in energy prices since OER is computed net of utilities costs. See macroblog for an excellent discussion. Of course OER held the core low during the housing boom. (Ironic, isn't it?) If the rental market continues to improve and energy prices continue to fall, this effect could be with us well into 2007. Does the fact that the rise in the core can be partly explained by the rise in OER make it less troubling? Perhaps slightly, but be careful not to discount it too much. In the last couple years when OER was holding the core down, the core rate was already at the top end of the Fed's comfort zone. If the current rise in OER is the most important change to affect the core in recent months, then not much has changed. The core was rising at slightly more than a 2% rate for most of last year. If the current trend in OER continues, the core inflation rate could top out above 3%. If a simple back-of-the-envelope calculation suggests that after adjusting for OER's effect the core inflation rate has been up around 2.5% or higher for all of that time, that would still be too much for most.
In short, these numbers don't inspire me to call for a rate cut right now. However, there is an interesting question of whether the FOMC's assessment of risks has changed since the last meeting. Aside from the OER component of core inflation (which we can reasonably expect to rise a bit more--and which is somewhat more predictable), it does appear that the risk of additional inflation may have diminished. But the fact remains that the current level of inflation remains too high in the eyes of many. Facing this fact, will the Fed hold rates at this level for an extended period of time or begin raising them again? Given the suggest of "opportunistic disinflation" a decade ago, it is reasonable to expect that they might try that strategy again and hold steady for a while.
Today's CPI figures do not totally clear up the fog of uncertainties. They reinforce the fact that this is still a critical time for the economy. Given the "wait-and-see" stance of the Fed currently, I think it will take more than this to move them off of that position. Will core inflation rates on the wrong side of 3% be enough to effect a change in policy? We may find out.
(Archived BLS press release of today's CPI report)
Posted by William Polley at October 18, 2006 11:20 PM
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Comments
For a different view of how legit the CPI is -- visit Shadow Government Statistics: http://www.shadowstats.com/
Posted by: Charles Ponzi at October 26, 2006 7:37 PM