The headline consumer price index (CPI) was unchanged (0.0% m/m) in June, weaker than the 0.1% increase markets were expecting. A 1.6% drop in energy prices on the month and flat food prices offset a 0.1% increase in core prices. Inflation on a year-on-year basis continued to cool, and now sits at 1.6%, the lowest reading since last October.
Given the loss of headline inflationary momentum in recent months, all eyes were on core inflation where a modest 0.1% increase brought the streak of soft readings to the fourth straight month. Core inflation was 1.7% year-on-year in June, matching the previous months’ pace.
Within the core, services inflation posted a moderate 0.2% m/m increase, supported by higher prices for shelter (+0.2% m/m). Prices for medical care (+0.4%), motor vehicle insurance (+1.0%), education(+0.3%) and personal care (+0.3%) all increased. These gains were partly offset by lower prices for airline fares (-2.7%), both new (-0.3%) and used (-0.7%) vehicles, and wireless telephone services (-0.8%).
Overall the tug of war in core inflation between falling goods prices (-0.1%) and rising services prices (+0.2%) continued in June. That dynamic has been in place since 2014, exacerbated by a strong U.S. dollar. Now, the services side of the rope is losing some strength. Core services inflation was 2.5% y/y in June, a notable cooling from the 3.2% pace in Q3 2016. Meanwhile core goods prices are in deflationary territory, down 0.6% from a year ago, a pace that has been reasonably steady over the past year.
Key Implications
Well, it could have been worse. Bond yields are lower on the disappointment in June inflation, but we take some solace from the fact that prices for core services continued to post moderate 0.2% monthly increases, deflation in core goods let up slightly in June and some areas of idiosyncratic price declines have reversed. Moreover, the deflationary impact of a stronger U.S. dollar over the past two and a half years is expected to ebb in the coming months given the dollar performance as of late.
Earlier this week, Fed Chair Janet Yellen emphasized the idiosyncratic nature of the recent loss of momentum in core inflation. While one-off price drops in specific categories are part of the story, it doesn’t explain the entire weakening in inflation seen in measures of inflation that strip out such volatility (trimmed mean or median CPI). Inflation has weakened across many advanced economies, suggesting that a broader phenomenon – such as persistent economic slack globally – may be playing a role.
Given an increasingly tight labor market, we expect inflation pressures to build through the remainder of the year, but the process is proving slower than expected. This adds considerable risk to the pace of Fed hikes over the rest of this year and in 2018.
