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United States Inflation May 2018

United States: Headline inflation picks up to a six-year high in May, paves the way for Fed rate hike

Consumer prices rose 0.2% from the previous month in May, matching April’s print. The result matched market analysts’ predictions, and notably reflected a 1.7% increase in prices at the pump, which had already risen 3.0% month-on-month in April amid upward momentum in the oil market. It was also impacted by a firming up of core consumer prices; on the other hand, food prices were flat in the month. Meanwhile, inflation showed signs of a durable pick-up in May, accelerating from April’s 2.5% to a more than six-year high of 2.8%.

Core consumer prices, which exclude volatile items including food and energy prices, rose 0.2% from the previous month in May, up 0.1 percentage points from April’s reading and in line with market analysts’ expectations. Shelter prices rose 0.3% month-on-month in May, as prices for lodging away from home recorded their steepest monthly increase since mid-2017. Prices for medical care also recorded healthy gains, driven by a jump in prescription drug costs, while moderate price increases were recorded for new vehicles and motor vehicle insurance. Conversely, airline fares, and used cars and trucks again logged large price declines in May, albeit less steep than in April.

Meanwhile, core inflation inched up from 2.1% in April to 2.2% in May, the highest level since January 2017. The May core PCE inflation reading, the Federal Reserve’s preferred measure of inflation, is expected to follow a similar dynamic. Furthermore, the increasing differential between core and headline inflation indicates that the pick-up in headline inflation in recent months partially reflects the current upward trend in energy prices.

Despite the headline reading reaching a multi-year high, the May inflation data is unlikely to have much of an impact on the current debate among Fed officials. The 12–13 June FOMC meeting is already expected by the vast majority of analysts to deliver the second rate hike of the year, which would bring the federal funds rate to between 1.75% and 2.00%, up 25 basis points from current levels.

The most pressing question immediately thereafter will be whether the Fed leans towards one or two additional rate hikes this year. Fed officials have declared in recent months that they would be willing to (temporarily) tolerate inflation moderately overshooting its target, after years of prolonged undershoots. The Fed’s preferred measure of inflation, the core PCE price index, was at 1.8% in April, still under the Fed’s 2% target, meaning that it is unlikely the Central Bank will see the May CPI reading as alarming just yet. Nevertheless, while the baseline scenario has been three rate hikes for several months, as of March, FOMC committee members’ forecasts were split evenly between three and four rate hikes. The balance of risks is therefore clearly tilted towards four rate hikes, given the solid inflation dynamics. The Fed is thus likely to keep its options open following the June meeting, and could very well, without tipping its hand, suggest the possibility that the next rate increase might come earlier than expected, in September instead of December.

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