Consumer Prices Heat Up

Higher prices for shelter, medical care, and tobacco fed the stronger-than-
expected rise in core CPI, which will keep the Fed focused on inflation

The consumer price index (CPI) rose 0.2% in January, while the core rate (excluding food and energy) rose 0.3%, which is a bit hotter than expected. Those compare to 0.4% and 0.1%, respectively, in December. Treasury prices sank on the bearish inflation news, sending yields higher by a couple of basis points.

In the Feb. 21 report, energy prices fell 1.5%, after rising 4.2% in December, while gasoline prices declined 3%, compared to a 6.9% increase in December. Housing was up 0.2%, with the owners' equivalent rent measure up a tame 0.2% from 0.3%. Tobacco prices surged 3.1%, vs. 1.5% in December, adding to the strength in the core rate, as did the 0.8% rise in medical care costs.

Price Pressures Could Last

The data left the headline year-over-year rate dropping to 2.1% from 2.5% in December. But the core year-over-year rate increased to 2.7% from 2.6%—above the 1.5%-2.5% comfort zone of the Federal Reserve.

In fact, the 2.7% January year-over-year gain for core inflation will likely be repeated in February if core prices rise by just 0.2%. And the January drop in the headline year-over-year rate from 2.5% to 2.1% will be followed by a gasoline-led bounce in February and March to the 2.3%-2.4% area if we see the expected 0.3% headline gains.

Today's data matched the price pressures signaled by the stubbornly firm ex-petroleum trade price figures for January, but bucked the lean producer prices index (PPI) figures from the January report released Feb. 16.

FOMC Concerned

Looking ahead to another key inflation gauge, we expect the January personal consumption expenditures (PCE) report to reveal a 0.1% headline chain price figure, and 0.2% core gain. As with CPI, the PCE chain price figures will be held down by lean gasoline prices, as was also revealed in the January retail sales report.

The firmness in today's core price data has also taken a small chunk out of our "real" consumption spending forecast for the first quarter, where we now expect 4% growth, though we will leave our first-quarter gross domestic product (GDP) estimate at 3.0%.

While inflation pressures have come off with commodity prices since mid-2006, trends in the year-over-year core index still remain well above the 2% "soft" target of most Fed members. This will keep the Federal Open Market Committee concerned about inflation pressures, given the continued momentum in the economy.