Falling gasoline prices mask rise in core CPI

The CPI, or Consumer Price Index, fell 0.2% in June as expected amid a 4.4% decline in energy prices, including a 6.8% decline in gasoline prices.

Food costs were also well behaved, rising just 0.2% last month, the smallest increase since last December.

But falling energy prices last month masked an overall upward trend in retail inflation.

The core CPI, which excludes the more volatile food and energy categories, rose 0.3% in June, the second such monthly increase in as many months.



Year-over-year, the CPI held steady at 3.4%, while the core CPI edged up from 1.5% to 1.6%.

At 1.6%, core inflation, which has been creeping higher, appears to be relatively well behaved. But the y/y rate does not reflect the recent jump in the broader price level.



Thanks mostly to higher auto and apparel costs, core inflation is up 3.0% at an annualized pace over the last six months, according to government data.

That’s well above the Fed’s implied target of just under 2%! Of course, I'm not comparing apples to apples, i.e., y/y versus a six month annualized pace, but the recent uptick, though transitory in the Fed's view, is a bit troubling.

QE3 chatter
On Wednesday, Fed Chief Ben Bernanke opened the door to another round of monetary easing, offering three different options – two of which have largely been untested.

Stocks reacted favorably but Bernanke dampened enthusiasm on Thursday.

“We’re not prepared at this point to take further action,” Bernanke told a Senate panel yesterday in his Q&A session, per Bloomberg news.

“Today the situation is more complex,” he told lawmakers. “Inflation is higher. Inflation expectations are close to our target.”

With core inflation moving forward at an annualized pace over the last six months of 3%, inflation is up, which is complicating the Fed’s job.

A side note: In my view, the $600 billion in bond purchases between November and June have played a significant role in rising commodity prices (see QE2 and its economic impact – chart 2).

And businesses, which still must deal with fragile aggregate demand, have had some success in passing along higher costs.

So it was not surprising to hear Bernanke put the brakes on QE3 chatter, especially since, there was a two month gap between the first mention of new bond buys and the actual implementation of QE2.

The Fed will continue to closely monitor economic activity, especially job creation. And if we continue to see weak growth, odds of  a policy shift will rise.