US CPI Inflation in May

The May US CPI data release provided yet another upward jolt to inflation. Monthly CPI inflation was 0.6% in May, down from 0.8% in April, but enough to push up annual CPI inflation to 5.0% in May from 4.2% in April.¹ This is the highest annual inflation rate recorded since 2008.

Core inflation, defined as “all items less food and energy,” rose by 0.7% in May, down from 0.9% in April, but boosting annual core inflation to 3.8% in May from 3.0% in April.

With monthly inflation running high in March, April and May, it is clear that a new picture of inflation is emerging. Annual inflation rises if the observations that drop out are smaller than the observations that enter the calculations. Indeed, as shown by the brown pillars in the chart below, this “base effect” played a major role in pushing up inflation in March and April as expected, but played little role in May.²

It is now becoming increasingly clear that the new monthly inflation rates are also high (light blue pillars). To stabilise inflation at 2%, the monthly inflation rates must average 0.17%. Yet in February monthly inflation was 0.4%, in March 0.6%, in April 0.8% and now in May 0.6%. While it is too early to say how monthly inflation rates will evolve in the months to come, further declines are necessary for the increase in inflation to be temporary.

Chart 1. Headline Inflation

Source: BLS, EFG calculations as at 10 June 2021

Given the rapid rise in inflation, it is of interest to ask how inflation is evolving relative to a forecast made in December. Such a forecast would have anticipated higher inflation due to the base effects, but not the rising monthly inflation rates from February onward. However, a confidence band around that forecast would recognise that temporary swings in inflation have occurred in the past and could happen again.

The figure below shows such a forecast, together with a fan chart that indicates the degree of uncertainty around that forecast. There are two main messages.

First, inflation was expected to rise and peak in May. There is thus nothing surprising with the increase in inflation.

Second, actual inflation is now just outside the 80% confidence band.³ The rise in inflation is thus stronger than anticipated. While it is not so far outside the band that it is obvious that the inflation process has changed, there is no denying that inflation is uncomfortable high, and it may remain at this elevated level for longer than initially forecast. The real test will come in the next few months. If inflation remains elevated even as the base effect washes out that will suggest that underlying pressures have risen. Alternatively, if inflation declines sharply over the next few months that would be consistent with a return to pre-covid conditions.

Chart 2. CPI inflation and forecast

Source: BLS, EFG calculations as at 10 June 2021

¹ While the annual inflation rates are computed using the seasonally unadjusted data, the monthly inflation rates are computed using seasonally adjusted data.
² The rest of the analysis uses continuously compounded growth rates.
³ The model attaches an 18% probability to inflation being this far from the central forecast.