Headline CPI up but core inflation remains muted

The Consumer Price Index rose 0.4% for the second straight month, as higher energy and food prices lifted the headline number. Core inflation, which strips out the more volatile food and energy categories, remained under control, rising 0.2% in January.

Though modest, the rise in the core rate was the fastest increase in 15 months according to data supplied by the BLS.



As expected, energy was among the big gainers, with prices rising 2.1% in January.  Gasoline posted a 3.5% rise.

Food costs, which have remained under control at the retail level, are now beginning to react to the steep rise in agricultural commodities, as prices rose 0.5%.

Apparel prices also jumped but housing/shelter barely increased.

Year-over-year, the CPI is now up 1.6%, versus 1.5% last month, while the core rate of inflation, which the Fed keeps a closer eye on, rose from 0.8% y/y to 1.0% y/y.

Looking at the chart above, the core rate of inflation has likely bottomed given the continued rise in commodity prices and the broadening economic recovery. But at just 1.0%, it remains well below the comfort level of policymakers at the Fed.

I suspect that in the short-term, the forces keeping a lid on inflation, including the slack in the economy, reasonably-well anchored inflation expectations (that’s a big one) and minor wage increases, will more than counter the significant rise in raw material prices and excess liquidity being pumped into the economy by the Fed.

And the very low level of core inflation makes it much easier for the Fed to maintain its planned purchases of $600 billion in longer-term government securities, especially since growth in nonfarm payrolls has been extremely lackluster.

What the Fed must do is implement an exit strategy that does not wreck the still-delicate but broadening recovery while not waiting too long, which might make it difficult to contain inflation at the retail level.

The Fed has insisted on many occasions that it has the means and ability to remove the excess stimulus without threatening price stability.  However, the Fed has typically remained on the accelerator for too long in past cycles.

A second option – hefty anti-inflation rhetoric at the appropriate time – might also be part of its arsenal of weapons, as it hopes to contain any potential rise in inflation expectations.

One thing appears to be certain, the best news on inflation is very likely behind us, as the core rate appears to have bottomed in October at 0.6% y/y.