Looking beyond the core, inflation remains elevated

The Federal Reserve has been expecting inflation in the United States to moderate for some time. At first sight, yesterday's report on consumer prices appears to confirm that expectation. However, the underlying inflation trend may not be so favourable.

Many analysts looking at yesterday's inflation report from the Labor Department focused on core consumer prices excluding food and energy, and by that measure, the inflation trend looks good. Core prices rose only 0.1 percent in March, showing a moderation after gains of 0.2 percent in February and 0.3 percent in January.

However, by other measures, the inflation trend looks less benign. The overall consumer price index was up 0.6 percent, showing an acceleration after gains of 0.4 percent in February and 0.2 percent in January. Energy costs were the main driver in the overall rise in consumer prices in March, with gasoline prices jumping 10.6 percent.

Removing the volatile components of the CPI does little to improve the apparent inflation trend. The 16-percent trimmed mean CPI and the median CPI monitored by the Federal Reserve Bank of Cleveland both rose by 0.3 percent in March, about the same rate as in recent months.

The following table from the Cleveland Fed shows the recent monthly percentage changes in all these indicators.

	Oct	Nov	Dec	Jan	Feb	Mar
CPI	-0.4	0.0	0.4	0.2	0.4	0.6
CPI less food & energy	0.1	0.1	0.1	0.3	0.2	0.1
16% trimmed-mean CPI	0.1	0.1	0.2	0.3	0.3	0.3
Median CPI	0.3	0.2	0.3	0.2	0.3	0.3

The next table, showing the percentage changes in these indicators over the last 12 months, makes it even clearer that inflation remains elevated and is not likely to fall to the Federal Reserve's comfort level of 2 percent any time soon.

	Oct	Nov	Dec	Jan	Feb	Mar
CPI	1.3	2.0	2.5	2.1	2.4	2.8
CPI less food & energy	2.7	2.6	2.6	2.7	2.7	2.5
16% trimmed-mean CPI	2.7	2.6	2.7	2.6	2.8	2.8
Median CPI	3.5	3.6	3.6	3.6	3.6	3.5

Yesterday, the Federal Reserve released a report on industrial production that also suggests that there will be little relief in inflationary pressures from this front. Industrial production fell 0.2 percent in March but manufacturing output increased 0.7 percent. Total industry capacity utilisation is at 81.4 percent while manufacturing capacity utilisation is at 80.1 percent. Both are within about one percentage point of cycle peaks and, indeed, have stayed relatively stable over the past six months.

And with the Federal Reserve also reporting last week that growth in money supply as measured by M2 accelerated to an 8.4-percent annual rate in the three months to March, perhaps we should not write off the possibility that inflation may even accelerate some time in the not-too-distant future.

The Federal Reserve is not the only central bank concerned about inflation.

Yesterday also saw the Office for National Statistics report that the consumer price inflation rate in the United Kingdom hit 3.1 percent in March, well above the Bank of England's target of 2 percent and forcing BoE governor Mervyn King to write a letter of explanation to the Chancellor of the Exchequer. Another rate hike by the BoE in May is now expected by most economists.

On Monday, Eurostat reported that consumer prices in the euro area increased 1.9 percent from a year earlier in March, up from a 1.8-percent rise in February. On a monthly basis, prices in March were up 0.7 percent from the previous month, the fastest rate of increase in almost a year. This was despite consumer prices in Germany rising by only 0.2 percent in March, although even in Germany the annual inflation rate edged up to 2.0 percent in March from 1.9 percent in February.

So there is good reason to remain concerned about inflation worldwide, as even the International Monetary Fund acknowledges. In its latest World Economic Outlook report, the IMF said that inflation pressures in the advanced economies have "generally eased" but "concerns do remain". Some factors it cited for the concerns include slowing productivity growth in the US and low unemployment and high capacity utilisation rates in the euro area.

The IMF also noted that real interest rates are "generally below long-term averages". Indeed, according to Bloomberg, yields on 10-year government notes yesterday were at about 4.7 percent in the US, 5.1 percent in the UK and 4.2 percent in Germany. Based on the latest 12-month inflation rates, real interest rates are only around 2 percent.

It remains to be seen how long such low real interest rates will take to tame inflation.