While the June CPI numbers showed inflation to have dropped significantly, there are reasons for caution. A single month can be misleading and inflation is still above the Fed’s target.

In Focus - Red Seeks Black

The June CPI numbers this past week were greeted with relief – inflation is subsiding! The broad CPI index was up only 3.0% over 12 months earlier, the smallest increase since March 2021. Core CPI, excluding volatile food and energy categories, was up 4.8% over 12 months.

For broad CPI, increases in the cost of shelter accounted for 70% of the monthly increase. That meant that enthusiasts who like to exclude shelter costs (for complicated reasons, but they’re out there) got even cheerier readings.

Before we decide inflation is vanquished, however, we can use this week’s chart to delve into some details. If it looks noisy, that’s the point.
Every month, new numbers come in for price indices (with seasonal adjustment). Thus, in raw form, both CPI and Core CPI were up 0.2% from May to June. Services were up 0.3%, commodities (less food and energy) down 0.1%, and energy up 0.6%.

There are a number of ways these sub-categories are typically reworked. One way is to annualize them: what would the rate be if it continued for 12 months? A 0.2% monthly increase equates to 2.4% annualized. That 0.6% rate would be 7.4%.

Alternatively, one can look at the inflation rate over the last 12 months, as reported above. That smooths out the month-to-month variation. For that volatile energy series, prices actually fell 16.7% over the last year – a big reason that headline CPI is so much lower than Core.

The problem with looking at 12-month numbers is that, with a volatile series, they can bounce around a lot because of events that happened a year ago, known as base effects. If prices were unusually high in a category in June 2022, inflation may look low, and vice versa. That’s one reason that the Federal Reserve and other analysts prefer less-volatile series.
Whereas we usually try to employ one of these tricks to smooth things out, this month we give you unfiltered June over May CPI in our chart. We exclude energy because it blows out the scale and makes it hard to see anything else.

The dark, thick horizontal line is a reference at 0.165%. If inflation hit that monthly level for 12 months, it would deliver the 2.0% inflation the Fed is looking for.

The red line is Core CPI. Before the Covid shock in Spring 2020, it fluctuated very near the target line. It also looks like a smoother version of the dark solid moving line – headline CPI.

One virtue of looking at the noisiest numbers is that it shows why it was difficult to recognize there was a problem with inflation. The numbers bounced around quite a bit until it became clear in mid-2021 that they were consistently above the Fed’s target.

There are three lessons we can take from the most recent section of the graph, covering 2023. First, the different inflation measures are all down notably from their peak. Second, they are centered distinctly above the target line, not around it as they were pre-Covid. Third, there is a great deal of volatility in monthly readings.

The first point is encouraging. The second will tell the Fed that its job is not done. The last point is cautionary: it’s better not to get too excited about a single month’s set of numbers.

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Last week we covered Italian Manufacturing Exports to the United States.

Economic Developments

German headline inflation in June broke a three-month downward trend, rising 0.3% from May to an annualized rate of 6.4%. Core inflation, which excludes energy and food, increased 0.4 percentage points to 5.8%, however. That marks a return to the same level of inflation reported in March and April.

Euro area economic sentiment fell for the second month in a row in July, reaching the lowest level since last December. Inflation expectations improved from last month, but at -79.1 remain firmly negative. Euro area financial markets are projected to continue weakening as short-term interest rates increase in the eurozone and the US, and export markets decline.

UK monthly real GDP shrank 0.1% in May after a 0.2% increase in April, resulting in no growth over the three months leading up to May. Production output, which fell by 0.6%, and construction output, which decreased by 0.2%, were the biggest causes of the downturn.

Euro area industrial production for May rose by 0.2% month-on-month but was still down 2.2% compared to May 2022. Production was lower by 5.4% for intermediate goods, 5.0% for durable goods, and 2.8% for non-durable goods.

The Michigan Consumer Sentiment Index increased by 12.7% from 64.4 in June to 72.6 in July, reaching its highest reading since September 2021 and 41.0% higher than in June 2022. However, the index is still well below pre-pandemic readings. The rise can be attributed to a consistently strong labor market and inflation slowing down.

Last week’s major trade data releases showed exports down almost across the board.

• China exports in US dollars increased 0.5% month-on-month in June to $285.3 billion, but were down 12.4% year-on-year, the steepest since February 2020. Exports of “High-tech products,” including LCDs and semiconductors, were down 14.1% through June compared to the same period last year. In particular, exports to the US were down 23.7% in June, and exports to the EU and the ten ASEAN (China’s largest trading partners), fell by 12.9% and 16.9%, respectively.

• UK real goods exports fell 3.2% month-on-month in May, with a 4.9% decrease in exports to the EU and 1.5% decline in exports to non-EU countries. The fall was driven primarily by weakened fuel exports to both EU and non-EU countries. There were also fewer medicinal and pharmaceutical shipments to the EU (Germany and Belgium).

• Euro area exports of goods to the rest of the world were estimated to be 2.3% lower in May 2023 than in May 2022. Goods imports from the rest of the world fell by a steeper 12.8% by the same measure, marking the biggest year-to-date decline since January 2021. Intra-euro area trade declined by 5.7% in May 2023 compared with the same period last year. The figures are adjusted for seasonality and calendar effects but not prices.

• Singapore’s non-oil re-exports declined 13.7% year-on-year in June. Once again the largest decline was in electronics, which were down 17.1% after a 19.8% drop in May; year-to-date they are down 18.7%. Singapore is one of the world’s busiest ports and is a key transshipment hub for inter-Asia and intra-ASEAN trade of intermediate and finished goods.

Political Developments

The The Bank of Canada raised its target overnight interest rate by 25 basis points to 5%, continuing its contractionary policies. Stronger than expected demand and tight labor markets were cited as two factors involved in the decision. The Bank also pushed back its prediction for headline inflation to come back down to the target 2% to the middle of 2025. by 25 basis points to 5%, continuing its contractionary policies. Stronger than expected demand and tight labor markets were cited as two factors involved in the decision. The Bank also pushed back its prediction for headline inflation to come back down to the target 2% to the middle of 2025.

Germany released its first “Strategy on China,” announcing that it would reduce its dependence on its biggest trading partner amid growing political tensions and asymmetry in access to markets such as the transportation sector. There was an emphasis on decreasing risk in supply chains, particularly with semiconductors and emerging green technologies.

The UK formally signed the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) treaty on Sunday, becoming the first European member of the Indo-Pacific trade bloc. More than 99% of current UK goods exports to CPTPP countries will be eligible for duty-free access over time, with tariffs on cars reduced to zero within 7 years. The direct economic benefits are estimated to increase the UK’s GDP by 0.08%.

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