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United States Inflation May 2019

United States: Headline and core inflation edge down in May, strengthening the case for a Fed rate cut

Consumer prices increased 0.1% over the prior month in May, down from 0.3% in April but matching market expectations. The print was mostly driven by higher prices for food, medical services and housing, while energy prices dipped, contrasting the strong monthly increases registered in previous months. Moreover, prices for used cars and trucks continued to decline substantially. Core consumer prices—which exclude volatile items such as food and energy—also rose a mild 0.1% month-on-month again in May, matching the previous three readings.

Inflation edged down slightly more than anticipated by market analysts, falling to 1.8% in May (April: 2.0%; expectations: 1.9%). The slowdown came against a backdrop of muted price pressures—or outright price declines—for core goods such as apparel and commodities (excluding food and energy commodities), as well as declining energy prices and modest food inflation. This however contrasted robust price pressures for services, particularly housing. Meanwhile, core inflation also ticked down from 2.1% in April to 2.0% in May.

As for the outlook, the recent fall in oil prices since the latest U.S.-China tariff escalation in May, combined with decelerating domestic and global economic momentum, suggests that price pressures should remain under control going forward, giving arguments to the Fed to justify its dovish stance and the possibility of a preemptive rate cut—as hinted by Fed Chairman Jerome Powell in recent weeks. As Leslie Preston, senior economist at TD Economics, puts it, “the weakness in inflation is starting to look less transitory. While core CPI inflation is still at 2.0%, the Fed’s preferred measure has typically been a few ticks lower, and today’s report does not bode well for an uptick in inflation there. If the Fed is looking for data to justify a more dovish stance at next week’s policy meeting, this is it.”

Nevertheless, economists at Nomura expect tariffs on Chinese imports will buttress inflation in coming months, noting that “if the fourth tranche of Chinese tariffs is introduced in Q3 as we currently expect, we think core goods price inflation will likely accelerate notably”. However, according to Preston, the Fed would likely attempt to look through these temporary distortions when making policy decisions.

Overall, the Fed is likely to stand pat at its June meeting but to double down on its dovish forward guidance and signal possible rate cuts later this year. As summarized by James Knightley, chief international economist at ING, “we believe that [Fed officials] will use next week’s June FOMC to signal an easing bias. This would perhaps be through repeating Fed Chair Jerome’s Powell use of the “closely monitoring” phrase and downward revisions to the economic projections and the “dot” diagram, which currently has a rate hike priced in for 2020. While we doubt that the Fed will carry through with the 100 basis points or so of policy easing currently priced by markets, the longer trade tensions drag on, the greater the chance the Fed will be forced to respond aggressively.”

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