So Is It Inflation, or Was It Just Gas?

The headline CPI declined 0.2 percent in June, as gasoline prices fell 6.8 percent. Prices rose elsewhere, however. Food costs rose 0.2 percent, and prices excluding food and energy items climbed 0.3 percent.

Falling Gas Prices Provide Some Near-Term Relief

Gasoline prices fell 6.8 percent in June, as the price of a gallon of regular unleaded gasoline fell from close to $4.00 a gallon in May down to $3.65 a gallon in late June. Prices for fuel oil and electricity also declined in June, which helped pull overall energy costs down 4.4 percent for the month. Even with June's declines, prices for most energy products remain sharply above their year-ago level. Gasoline prices are up 35.6 percent year-to-year, while fuel oil costs are up 28.3 percent. Excluding the energy sector, prices rose 0.2 percent in June and are up 2.0 percent over the past year.

Food costs also remain problematic. Grocery store prices rose 0.2 percent and are now up 4.7 percent on a year-to-year basis. Higher prices for meat and dairy items account for much of the rise. Prices are up less at restaurants, although the pace has picked up. The cost of dining away from home rose 0.3 percent in June and is up at a 3.2 percent annual rate over the past three months. Prices are up less year-to-year, rising just 2.3 percent, as restaurants continue to aggressively promote value menus.

Core inflation came in on the high side. Prices excluding food and energy items rose 0.3 percent and are up at a 2.9 percent annual pace over the past three months. Some of this increase should prove transitory. Prices for new and used vehicles rose 1.0 percent in June. The rise likely reflects shortages of some popular models emanating from the Japanese earthquake. With inventories lean, dealers are not discounting as much as they usually do at this time of year. Prices for new vehicles are up 4.0 percent year-to-year, while prices for used vehicles are up a whopping 5.1 percent. Clothing prices have also jumped up in recent months. Prices for apparel rose 1.4 percent in June, following a 1.2 percent rise in May. The increases reflect sharply higher cotton costs and fairly lean inventories of popular fashions.

Owners' equivalent rent, which accounts for 32 percent of the core CPI, picked up slightly in June, rising 0.2 percent. This key component has remained relatively well behaved, however, climbing just 1.0 percent over the past year. Rent for primary residences rose just 0.1 percent in June, but are up slightly more on a year-to-year basis, climbing 1.4 percent. The rise in imputed and actual rents is still well short of what is being reported by major apartment REITs. We expect the rental components to rise more rapidly over the next 18 months, keeping upward pressure on the core CPI.

June's 0.3 rise in the core CPI brings the closely watched 12-month change to 1.6 percent. Core inflation is rising slightly more than the Fed projected but remains within acceptable norms. The real question for policymakers is if core inflation can accelerate this much with a feebly growing economy and 9.2 percent unemployment, what will it do once economic growth finally strengthens for real.