Monday, 21 July 2008

US inflation not moderating yet

Last week's report on the consumer price index for the United States shows that inflation is not abating. In fact, it appears to be accelerating.

The Labor Department reported on 16 July that the overall CPI rose 1.1 percent in June, accelerating from 0.6 percent in May. The CPI excluding food and energy rose 0.3 percent in June, accelerating from 0.2 percent in May.

The overall CPI in June was 5.0 percent higher than the level 12 months ago, the biggest increase since 1991. The CPI excluding food and energy rose 2.4 percent in June from 12 months ago, a more subdued rate of increase.

However, it is now quite apparent that the CPI excluding food and energy has been a poor measure of core or underlying inflation in the US over the past few years (see "Elevated US headline inflation proves persistent" for a fuller discussion) so its subdued level is of little comfort.

Other measures of core inflation appear less benign. The Federal Reserve Bank of Cleveland monitors two such measures: the median CPI and the 16% trimmed-mean CPI. These alternative measures of core inflation also accelerated in June, both increasing by 0.4 percent compared to 0.2 percent and 0.3 percent respectively in May. Compared to the levels 12 months ago, the median CPI was higher by 3.1 percent in June while the 16% trimmed-mean CPI was higher by 3.2 percent.

Most economists expect a slower economy to eventually pull inflation down. So why is inflation still accelerating?

The simple reason is that it is still too early.

On the same that the Labor Department reported the CPI, the Federal Reserve released information on industrial production and capacity utilisation. The former was up 0.5 percent in June, turning around from a 0.2-percent fall in May, although the longer-term trend is still down. Capacity utilisation also rose to 79.9 percent from 79.6 percent. The former remains close to the cycle peak of 81.4 hit in July last year.

In other words, slack in industrial capacity has not increased much from the cycle peak despite the economic slowdown. Historically, a peak in inflation is usually seen only after a considerable period of sustained decline in capacity utilisation.

So when will inflation actually decline? The minutes of the Federal Open Market Committee meeting in June released on 16 July show that members think this will happen in 2009. Inflation was expected to remain elevated in 2008 but "a projected leveling-out of energy prices and the anticipated slack in resource utilization" was expected to allow headline inflation to "decline considerably in 2009 from its pace in the second half of 2008".

Therefore, expect to see continued elevated inflation readings in the coming months.

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