U.S. October CPI: Inflation still high, but relief on the horizon

REAL ECONOMY BLOG | November 10, 2022

Authored by RSM US LLP

Inflation in the U.S. economy is approaching an inflection point where the central bank can begin considering a pause in its efforts to restore price stability and households can begin seeing possible relief from a deterioration in real income.

The October consumer price index, which rose by 0.4% on the month and by 7.7% from a year ago, supports our call that the Federal Reserve will slow the pace of its rate hikes.

Adding to our view is that early next year, negative base-year effects in energy prices will kick in. These easier comparisons to the surging costs of a year earlier will dampen their effect on inflation. It all means that the supersize rate hikes of recent months are now firmly in the rearview mirror.

Our core baseline call remains intact: The central bank will engage in a pause early next year.

Core inflation, which strips out volatile food and energy prices, increased by 0.3% in October and was up 6.3% over the past 12 months, according to government data released Thursday.

The primary catalysts for the increase in still-elevated inflation were the 1.8% monthly rise in energy, the 4.4% increase in energy commodities and the 4% increase in gasoline.

Service sector prices increased by 0.4% on the month and were up by 7.2% on a year-ago basis. Shelter costs increased by 0.8% in October and were up by 6.9% from a year ago, while the policy-sensitive owners’ equivalent rent series increased by 0.6% in October and by 6.9% over the past year.

Policy implications

The October data supports our call that the Fed will slow the pace of its rate hike campaign and lift the policy rate by 50 basis points at its December meeting.

Our preferred measure of pipeline pressure inside core inflation is the three-month average annualized pace of rent of primary residences, which increased by 9.6%, and owners’ equivalent rent of residencies, which rose by 8.9%. This does not imply that a pause or a pivot in the policy path is imminent.

Rather, it implies that the Fed can slow the pace of its efforts to restore price stability and then prepare the market for a pause sometime during the first quarter. We still think that it will be necessary to lift the policy rate to a range of between 5% and 5.25% early next year.

The data

As expected, there was a 2.4% monthly decline in used vehicle costs and a 0.5% drop in medical care costs.

The decline in medical costs should be understood in the context of the way in which the Labor Department measures health care costs: a lagging year-to-year change in health care firms’ profits, which are now falling and will provide a modest downward drag on the overall index for at least the next year despite rising premiums for consumers.

This applies only to the consumer price index and is not applicable to the personal consumption expenditures index, which is the Fed’s policy variable and uses a different methodology.

Overall, all items excluding food, energy and shelter declined by 0.1% on the month and were up by 5.8% on the year

Food and beverage prices increased by 0.6% and were up by 10.6% on the year.

During October, apparel prices declined by 0.7% on the month while transportation costs increased by 0.7%. New vehicle costs advanced by 0.4% in October while airline fares dropped by 1.1% Recreation prices increased by 0.7% on the month, while commodities costs advanced by 0.5%.

The takeaway

Inflation remains elevated and the policy path will not change based on this one report. We expect some easing in pipeline pressures and rather large negative base-year effects inside the energy complex that will bring down both headline and core inflation through the middle of next year.

For now, one can observe that the three-month average annualized pace in core services inflation is 8.1%. That is still too high for a reversal in the policy path by the central bank. But core goods inflation using that same metric declined by 2.1%, which is an encouraging development in the Fed’s efforts to restore price stability.