US CPI inflation falls in April, but discouragingly little

Core inflation, which also was 0.4% month-on-month, fell from 5.6% in March to 5.5% in April. However, core inflation has been fluctuating around this level since January of this year and has thus appeared resilient to the Fed’s interest rate increases.

To see better the evolution of inflation, the figure below shows headline inflation and its components: headline inflation is the sum of the rate of change of food and energy prices and core inflation, which in turn can be divided into shelter and core inflation excluding shelter.

Chart 1. Contributions to inflation (12 months)

Source: www.bls.gov. Data as at 12 May 2023.

The graph shows that in spring of 2021 inflation started to rise. To a great extent this was due to base effects, that is, the price falls that occurred in 2020 as the Covid pandemic spread dropped out of the calculation of 12-month inflation. While this was expected, the rise in inflation in the autumn of 2021 took commentators by surprise.

That increase was due to a combination of rising prices for food and energy and for the non-shelter component of core inflation. However, the shelter component also started rising but so gradually that few commentators took notice.

Headline inflation peaked in June 2022. Subsequently, its marked decline was largely due to a moderation of food and energy prices. Over time, however, core inflation excluding shelter also started to decline.

The figure also shows the main problem the Fed has been facing: the gradual increase in the rate of increase of the cost of shelter. From August 2022 onwards, it alone was responsible for pushing inflation above the Fed’s 2% target.

To see more clearly the behaviour of these inflation components, it is useful to look at annualised inflation over three months, as is done in the figure below. It shows that core inflation excluding shelter rose sharply in the spring of 2021 and in early 2022 and that it has contributed about 1 percentage point to the overall inflation rate in recent months. It also shows that the rate of increase in food and energy prices has fluctuated around zero since August 2022 and that it was negative in March and April this year.

Chart 2. Contributions to inflation (three months annualised)

Source: www.bls.gov. Data as at 12 May 2023.

The figure illustrates that the most important component of inflation is the rate of increase in the cost of shelter. It peaked at 3.2% in February but fell in both March and April and now stands at 2.4%. There is thus some evidence that the important and sluggish increase in the cost of shelter has started to turn.

What will the Fed think about these data? Without doubt it will focus squarely on the data for May, which will be released on 12 June, that is, two days before the FOMC meeting on 14 June. But given that so much of core inflation is due to the increasing cost of shelter, which changes only gradually over time, it seems unlikely that core inflation over 12 months will change much between April and May.

The Fed is therefore likely to focus more on other indicators, such as initial jobless claims, which have been rising in recent weeks, and measures of wage pressures, such the Atlanta Fed’s wage growth tracker, which has stopped rising in recent months and even declined a little. It will therefore be critical to monitor how these variables evolve before the next Federal Open Market Committee meeting.