The inflation outlook improved in March because of a mix of year-over-year base effects and a significant decline in energy prices, all of which caused the top-line reading to decline to 5% from 6% previously.
The core estimate, which excludes food and gasoline, eased to 5.6%, while the monthly readings showed a 0.4% increase in the core and a 0.1% advance in the top line, according to Labor Department data released Wednesday.
Core inflation remains somewhat sticky, but the data is moving in the correct direction and supports the case for a near-term pause in the Federal Reserve’s efforts to restore price stability.
While we are encouraged by a recent easing in the pace of hiring and inflation, we still hold to our longer-term view that it is unlikely inflation will return to the Fed’s 2% long-term target.
The effective return of industrial policy, a permanent change in supply chains and a structural change in domestic labor demographics all point to an inflation rate that will settle in at or above 3% on a long-term basis and will require a re-setting of the Fed’s inflation target to 3%.
Policy implications
Policy implications from the data are appropriately status quo. The Fed will almost certainly increase its policy rate by 25 basis points to a range between 5% and 5.25% at its meeting on May 3.
Core services excluding housing costs, known as supercore inflation, eased to 5.8% in March on a year-ago basis, down from 6.1%. That decline somewhat allays concerns about a wage price spiral at the heart of the Fed’s current rate-hike campaign.
Depending on the direction of jobs, the remaining March inflation data and April economic outcomes, it may then be appropriate for the central bank to consider pausing its rate increases to ascertain the impact of the recent banking turmoil as well as past rate hikes.
The data
The primary catalyst for easing of top-line inflation was the 3.5% decline in energy prices, the 4.6% drop in energy commodities, and the 4.6% fall in gasoline prices.
Commodities declined by 0.3% on the month and were up by 1.6% on an annual basis. Given the recent pledge by OPEC+ to reduce production by more than 1 million barrels a day, this may somewhat reverse in coming months. One should proceed with caution on assuming further small increases or large outright declines in the energy data.
Service sector prices remained elevated. This category, which accounts for 61.59% of the overall consumer price index, advanced by 0.3% in March and was up by 7.3% on a year-ago basis.
Services excluding energy increased by 0.4% in March and rose by 7.1% from a year ago. On a three-month average pace, service sector inflation was up by 4.5% and was still a bit too sticky for policymakers who are focused on the relationship between core services excluding housing and wages.
Like services, the housing component of the CPI remains elevated, with prices increasing by 0.3% on the month and by 7.8% from a year ago.
Shelter increased by 0.6% and 8.2% using those same metrics, while the policy-sensitive owners’ equivalent rent advanced by 0.5% and 8%.
We think that shelter costs are turning and that we will see larger declines in the coming months, which is supportive of a June pause by the Fed.
Food and beverage prices were flat on the month and up by 8.3% from a year ago. The cost of apparel advanced by 0.3% and was up by 3.3% on a year-ago basis.
Transportation costs declined by 0.5% on the month and were down by 1% from a year ago. New vehicle prices increased by 0.4% on the month and increased by 6.1% from a year ago. Used car and truck prices dropped by 0.9% in March and by 11.2% annually.
Medical care costs dropped by 0.3% and rose by 1.5% on a year-ago basis. Recreation costs increased by 0.1% on the month and were up by 4.8% over the past year.
