Still Not Much Heat in US Inflation – But is that a Barrier to Further Rate Hikes?

Highlights:

• All items CPI met market expectations with a 0.1% month-over-month increase in December. Lower energy prices limited the gain, unlike November when they contributed to a 0.4% headline increase.
• All items inflation edged down to 2.1% year-over-year from 2.2% in November.
• Excluding food and energy, prices were up 0.3% in December—the largest monthly increase since last January. December’s gain was helped by a 0.4% increase in the sizeable shelter component.
• Core inflation edged up to 1.8% year-over-year in December but has been stuck in a tight 1.7-1.8% range over the last eight months.

The December CPI report caps off a year that saw little evidence of tight economic conditions fueling higher consumer prices. The headline rate of 2.1% is exactly where it was a year earlier, while core inflation remains stuck below the Fed’s 2% objective after having been on the opposite side throughout 2016. That is despite the unemployment rate falling to 4.1%—below most estimates of what the economy can sustain without driving inflation higher. It remains the case that without the impact of one-off factors like a sizeable dip in wireless telephone service prices, core inflation would be right around the 2% mark. But still there is limited evidence that underlying inflation is actually heating up. That continues to be a sticking point for some members of the FOMC who are reluctant to raise interest rates further in the absence of greater inflationary pressure.

However, those on the other side who are concerned about upside risks to the inflation outlook now have a bit more ammunition thanks to the tax cuts passed in December. With the economy already running near full capacity, this fiscal boost arguably will need to be offset by tighter monetary policy. A pickup in inflation would certainly help make the case, but even if current price trends hold we think policymakers have to be concerned about falling behind the curve. So while core inflation is likely to remain stuck below 2% early this year, we continue to expect the Fed will raise rates again in March.