May CPI undershoots, but Fed caution remains

Both the headline and core CPI measures increased by 0.1% over the month, less than in April and below expectations. Whilst the month-on-month data was encouraging, we are not out of the woods yet with both headline and core measures above the Fed’s 2% inflation target on a year-on-year basis. The former increased by 2.4% over 12 months (2.3% in April) and the latter by 2.8% (2.8% in April).

For reference, the Federal Reserve has previously stated a preference for the core personal consumption expenditures (PCE) measure of inflation, which differs slightly to the CPI metric, primarily in terms of the weights applied to the various subcomponents. Historically, the PCE measure has been around 0.4 - 0.5 percentage points below the CPI measure. If that applies to the current situation then core PCE inflation would be only slightly above the Fed’s target.

One factor that has had a direct impact on the headline measure and an indirect impact on the core measure is energy prices. Thus, the energy commodities component of the CPI fell by 2.4% over the month and is down 11.6% relative to May 2024.

It is noteworthy that oil prices are down around $15 per barrel from this year’s January peak of $80. By itself this would impart a downward bias to inflation, helping to offset any inflationary impact of tariffs. Estimates vary but reversing the rule of thumb that a $10 increase in the oil price reduces growth by 0.1% and increases inflation by 0.2%¹, a $15 reduction in the price of a barrel of oil would impart a positive tailwind to growth of around 0.15% and push inflation lower by 0.3%. Other estimates suggest an even larger impact.

There are other reasons why there has been no discernible impact of tariffs on inflation so far:

1. Companies may have planned ahead by importing essential goods at pre-tariff prices. This is evident in the very strong import component of the first quarter GDP release.

2. There may have been a dampening in activity related to tariff uncertainty, which would have reduced pricing power.

3. It is possible that some companies are concerned about raising prices for fear that they may offend the Trump administration.

4. It may simply be too early for the impact of tariffs to be reflected in the data.

Putting this all together paints a picture that reinforces the view that the gentle downtrend in US inflation remains intact. The Fed will no doubt take some comfort from this but will require further supporting evidence in the months ahead before changing its policy stance.

¹Senate Banking Committee transcripts https://www.govinfo.gov/content/pkg/CHRG-117shrg55669/pdf/CHRG-117shrg55669.pdf (Page 26)

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