Consumer prices remained unchanged for the third consecutive month amid rapid job creation and wage growth, signaling to the Federal Reserve Board that planned interest rate increases may not be necessary after all.
The 12-month percent change in CPI in January, that is, the consumer inflation rate over the last year, was 1.6 percent, the lowest since June 2017. And the report from the Bureau of Labor Statistics shows that the core CPI, which takes out the indicator’s two most volatile components, energy and food, made the Fed’s target inflation rate by remaining at a stable 2.2 percent.
During 2018, the Fed raised interest rates four times to keep the economy from overheating, that is, from growing too quickly, with the risk of increased inflation. But the decreasing rate of inflation, as indicated by recent trends in the CPI, seems to be signaling that there is room for economic growth without inflation despite increasing wages –currently at 3.1 percent per year–, continuing job creation, and recent tariff hikes. In light of this, it is likely that the Fed will put off its plan to keep raising interest rates in 2019. This may come as a relief to President Trump who has expressed concerns over the dampening effect of increased interest rates on the economy.
Over the last quarter, a succession of 5 percent per month drops in gasoline prices, and commodity prices in general, has been holding down the CPI. This downward trend in energy prices is likely to continue in the medium term, given anticipated developments in the American oil industry.
“People have consistently underestimated the huge increases in US oil output, and we do think that that’s going to continue throughout this year,” said Michael R. Englund, chief economist for Action Economics LLC. “Three pipelines are scheduled to be completed in 2019. There will be a surge in oil output, and we think that will put a cap on prices, despite efforts by Russia and Saudi Arabia to support prices.”
The 12-month percent change in core CPI, which takes out energy and food, decreased steadily, even if slightly, over the last three months despite growing wages and salaries. This combination can happen when wage increases result from improved efficiencies in the production of goods and services. “A certain chunk of current wage increases is productivity,” said Mr. Englund.
Labor productivity increased by 1.3 percent in the manufacturing sector during the fourth quarter of 2018. “Once you account for productivity, we don’t see a 3.1 percent wage gain is problematic. In fact, we actually think a goal of policy should be to increase wage growth,” said Mr. Englund, adding that wage increases of 4 percent would be problematic, but that 3 percent increases would not affect the inflation outlook.
Tariff increases had a limited effect on core commodity prices (all but food and energy commodities) whose 12-month increase was 0.3 percent. “There is a mixed reading on the ability of companies to increase prices because of tariff increases,” said Scott J. Brown, Senior VP/Chief Economist for Raymond James and Assoc. Inc. Mr. Brown said that various factors are making incomplete the pass-over of tariff increases from companies to consumers: information flows are incomplete, and consumers are cost-sensitive because of increased competition from abroad and because of decreasing confidence in the economy.
Tax cuts from the 2018 tax reform seem to be impacting recent trends in CPI more than tariff increases. “There’s a lot of focus on tariffs, but tax cuts were about three times bigger than the tariff increases. People have talked about the upward impact of tariffs on inflation, but the fact of the matter is that massive corporate tax cuts imply downward pressure on inflation,” said Mr. Englund.
Because of increased profits from tax cuts, corporations have felt less need to increase prices. “On net, corporate taxes have been reduced even if you account for the tariffs imposed,” said Mr. Englund, adding that it was unlikely that tariffs would increase in the months to come because it looked like there was progress in talks with China. He also said that even if an additional 25 percent tariff were imposed, companies would still be experiencing a net tax cut.
The pockets of American consumers are being hurt the most by services other than energy services. In January, the 12-month increase in this category was 2.8 percent. Rent of shelter, the item that most affects the consumers’ pockets, rose a whopping 3.2 percent over the last year. Medical care services also rose 2.4 percent, as did health insurance (6.5 percent). In the event of a hike in energy prices, continued rises in prices of these sensitive services that take up a high proportion of every family’s budget, may mark the end of the current honeymoon of American households with the economy.