Consumer prices fell 0.1% (month-on-month) in December, in line with market expectations. The decline largely reflected a 3.5% drop in energy prices – the largest in almost three years and a 2% falloff in transportation. On a year-on-year basis, inflation edged down to 1.9% from 2.2% the previous month.

In line with  consensus estimate, core CPI prices (excluding food and energy) were up 0.2% (month-on-month) and 2.2% (year-on-year). Both remaining unchanged from November’s outturn.

Core goods prices rose 0.1% on the month, after a 0.2% increase the prior month, while core services rose 0.3%,up slightly from the 0.2% in November.

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Key Implications

The falloff in energy prices in recent weeks has resulted in more muted inflation dynamics. The 3.5% drop in energy prices is the largest since February 2016 and has taken much of the steam out of headline inflation.

Core inflation continues to remain contained at just above the 2% watermark, with an acceleration in core services offset by a slowdown in core goods.

Inflation closed out 2018 on a relatively stable footing, suggesting that it is contained around the Fed’s 2% target. As 2019 unfolds, rising wages stemming from the tightening U.S. labor market as well as previously imposed import tariffs could alter the inflation picture. Nevertheless, a soft price environment allows the Fed to be patient and maintain its flexibility in responding to the economic data. As such, we expect two rate hikes in 2019, with the first likely in June.

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