Thursday, February 21, 2008

Inflation refuses to ebb, US headline CPI increases 0.4% MoM in January

The US headline CPI increased 0.4% MoM in January, a pace akin to that in the previous month. Inflation of core prices (excluding volatile food and energy costs), which is closely watched by the Fed, edged up to 0.3% MoM (the fastest pace since June 2006) from a steady 0.2% in each of the preceding 9 months. On a YoY basis the situation looks much more alarming, as headline inflation jumped 4.3% from an already elevated level of 4.1% in the previous month while core inflation grew 2.5%, its highest annual rate since March 2007. At the current levels, the core CPI is substantially above 1% - 2% zone targeted by the Fed for core PCE, a worrisome sign for the Federal reserve officials who are already grappling with serious growth concerns. Core inflation has risen at an annual rate of 3.1% over the past three months.

The rise in headline CPI was largely driven by higher food (+ 0.7% MoM in January vs. +0.1% in December) and energy prices (+ 0.7% MoM in January vs. +1.7% in December) while Owners Equivalent Rent (+ 0.3% MoM in January vs. +0.3% in December) and apparel (+ 0.4% MoM in January vs. +0.1% in December) prices pushed up the core. Food prices (13.8% weight in headline CPI) have depicted the highest MoM increase since April 2005. Owner's equivalent rent, which accounts for 24% of the headline CPI and is a major component of overall housing, has been increasing at a steady pace of 0.3% MoM for the past three consecutive months. Housing, which accounts for 42% of the CPI Index, rose 0.2% MoM, a modest increase from +0.3% and + 0.4% in the previous two month. Although core inflation has been the Fed's preferred measure of inflation, the underlying price trends in energy, particularly crude oil prices, which have already touched the three-digit level and expected to remain elevated in the near term, is an area of grave concern. Mirroring the secondary effects of higher energy prices, transportation prices have increased 0.5% MoM (+1.0% previously) while airline prices have jumped 0.8% MoM. Gasoline prices, which account for about two-thirds of the overall transportation increase, rose 1.2%MoM in January (2.8% previously).

Although recent speeches by Bernanke have suggested that his focus has shifted, presumably temporarily, to inflationary expectation rather than actual inflation data; he cannot possibly ignore the steady rise in core inflation since the past three months (+3.1% YoY over last quarter). Going forward one sees ample risks to core as well as headline inflation in the form of surging crude oil and import prices. Non-fuel import prices rose 0.7% MoM in January and have risen at a 5.2% annual rate over the last quarter. Import prices in January have increased across countries with European Union (+1.1% MoM), Latin America (+2.8% MoM) and China (0.8% MoM) being the major contributors. While in the current scenario downside risks to growth are much severe than the upside risks to inflation, accelerating consumer prices will certainly carry a significant weight in future FOMC deliberations.

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