News Alert: Headline Inflation Drops but Core Inflation has Further to Fall

A modest rebound in gasoline prices in June was countered by the continuation of a sharp downward trend in food inflation leading to a modest increase of the headline Consumer Price Index (CPI) of 0.2% month-over-month. Base effects – the rolling off of the last of 2022’s large monthly increases in energy prices – saw the annual rate of inflation drop to a 27-month low of 3.0% from 4.0% the prior month. While encouraging, the Fed remains focused on core inflation which excludes energy and food price fluctuations that have driven much of the headline movement over the last several months.

Core inflation, as measured by Core CPI, rose at the same 0.2% month-over-month rate, which was below consensus expectations for a 0.3% rise, leading to an annual rate of 4.8% down from 5.3% the prior month. The lower-than-expected June result is potentially more encouraging than it may look as it was driven by a fall in used car prices of only 0.5% while more recent auction data points to a fall of almost 9% in used car prices over the next few months. Downward or slowing trends also continued in core goods, such as household furnishings and recreational items, along with a strong downward trend in shelter. The slowing rate of shelter inflation, which was primarily due to a fall back in owner’s equivalent rent to just 0.4% for the month from rates as high as 0.8% earlier in the year, is especially encouraging as shelter accounted for two-thirds of the increase in core inflation over the last year. There was also evidence of a decline in core services ex housing inflation, which has become the Fed’s latest focus in its inflationary battle. While much of the services ex-housing decline was caused by an 8.1% plunge in airfares, it is the sector that the Fed is currently focused on as they look for signs that core inflation is slowing.

However, the lower-than-expected rise in core consumer prices is highly unlikely to stop the Fed from its intention to hike interest rates again at the July meeting. As we’ve recently stated in response to the Fed’s June pause, the single data points for both inflation and employment are not enough to establish the persistent evidence that the Fed would need to change the course of action alluded to in June’s post-meeting comments, recent testimony by the Fed chair, and media comments from Fed participants. Nevertheless, the data from the June CPI report does support our belief that the downward trend in core inflation will continue and accelerate over the second half of 2023.