Inflation in the consumer price index (CPI) cooled in February as a 4% monthly decline in airline fares and a 1% drop in gasoline more than offset the 0.3% increase in the index for shelter.
The rise in the cost of shelter accounted for half of the increase in February’s CPI, where top-line and core inflation advanced by 0.2%. This increase translated to a 2.8% annual rise in the top-line index and a 3.1% advance in the core CPI from a year ago.
Service inflation and rents, however, are still advancing at well above a 4% rate. This, in conjunction with slowing growth, does not bode well for the economy or the number of rate cuts by the Federal Reserve.
The easing in prices linked to one-time declines in airline fares on the back of softer consumer demand provides a quantum of solace given the coming increase in goods prices because of tariffs, which puts at risk a multiyear trend in goods disinflation.
While the top-line CPI figure looks friendly, the underlying data implies that the Federal Reserve is looking at declining degrees of freedom when it comes to cutting rates.
The data
Right on cue, transportation costs declined by 0.4% on the month and the price of new cars dropped by 0.1%—just ahead of a large potential pricing shock to the industry.
A sign of this looming shock could be seen in the price of used cars and trucks, which advanced by 0.9% on the eve of 25% tariffs on steel and aluminum, which will push the cost of motor vehicles and parts higher.
More importantly, service sector inflation increased by 0.3% on the month and by 4.1% from a year ago.
Services excluding energy, or core services, also increased by 4.1%. Despite all the focus on the manufacturing sector and tariffs, the United States is a service-based economy, and service and housing inflation remains stuck in what accounts for 63.78% of the overall index.
Housing costs increased by 0.4% in February and by 3.9% from one year ago. Shelter costs advanced by 0.3% and 4.2% while the policy sensitive owners’ equivalent rent increased by 0.3% monthly and 4.4% annually.
As we have noted, the combination of slower growth—we think gross domestic product will arrive at 1.5% in the current quarter—and sticky inflation like that observed inside the service sector index create the conditions for stagnation at best and stagflation at worst.
Energy prices increased by 0.2% on the month and were down by 0.2% over the past year while gasoline prices declined by 1% on the month by 3.1% from a year ago.
Food and beverage costs increased by 0.2% monthly, apparel by 0.6%, medical care by 0.3%, education by 0.2% and commodities by 0.1%.
The surge in egg prices slowed, but those prices remain unacceptably high. They increased by 10.4% in February, which is below the 15.2% rise posted in January.
Other large notable increases included a 5.5% advance in men’s suits and outerwear, a 3.6% rise in girls’ apparel, a 7.2% increase in sporting tickets, a 3.3% advance in tax preparation and a 3.6% increase in jewelry and watches.
Read more of RSM’s insights on the economy and the middle market.
The takeaway
A cooler-than-anticipated CPI provides a quantum of solace given the sticky service and housing inflation that comprise 63.78% of the index and are advancing at a 4.1% pace from one year ago.
Even without energy costs factored in, the service sector increased by 4.1% over the past year as growth slows.
Given the onset of large trade taxes, it is important to remember one key fact: 40% to 45% of all imports are inputs used to produce final goods inside the U.S. The taxes on those imports and other tariffs will raise prices on finished products.
And that will end a multiyear disinflationary trend in goods, putting upward pressure on inflation.
