May 15, 2023
Core Inflation - Flexport Weekly Economic Report
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Don’t be fooled by improvements in headline inflation numbers. Underneath, core inflation looks steady and strong. Services have taken over from goods as the key driver of price increases.
In Focus - Steady Costly Services
The two most celebrated inflation numbers of this past week both seemed to show inflation cooling. They are deliberately excluded from this week’s graph. Here’s why.
The April Consumer Price Index (CPI) was up 4.9% over the last 12 months. That’s down notably from a high of 8.9% in June of 2022. Better yet, the index has dropped or held steady every month since then.
The April Producer Price Index (PPI) for all commodities has dropped 3.0% over the last 12 months. That’s a far cry from its peak increase of 22.7% in November 2021.
How could these two numbers indicate anything other than dramatic progress in the battle against inflation?
In the graph, the most eye-catching line is the green dashed line following the 12-month change in energy prices in the CPI. It swings so wildly that it sets the scale for the graph – and still jumps off the top with its 41.3% peak in June 2022. Note that the line is neither always high, nor always low – it’s noisy.
The other, gray dashed line is not quite as dramatic, but is still lively compared to the other ones. That’s the 12-month price change in food in the CPI.
While food and energy are each indisputably important, their price movements are not terribly informative about what the rest of the economy is doing. They move so drastically, though, that they can swing the overall index.
Hence the preference among central banks for core measures. Core CPI – the thick, black line in the graph – is just the regular CPI index with food and energy excluded. It presents a more sedate picture, perhaps distressingly so. Over the 12 months to April, core CPI inflation was 5.5%. Which is what it was in December 2021 and roughly what it was in the summer of 2022. It has held between 5.0% and 6.6% since November 2021.
It's not a story of stasis, though. In late 2021, Core CPI inflation was being driven by price increases in goods. In November 2021, CPI Commodities (excluding food and energy commodities) prices were up 9.5%. This is the light gray solid line in the graph.
Since then, inflation has abated rapidly for commodities. The most recent reading is 2.1% in April, which is actually up from 1.0% in February. This is the measure that is most likely to be driven by the falloff in PPI.
The core CPI number has been sustained by mounting, steady services inflation. CPI Services (less energy services, red on the graph) was up only 3.4% in November 2021, but 6.8% in April 2023.
Whereas CPI Commodities gets a 21.3% weight in overall CPI, CPI Services gets a 58.3% weight. Hence, replacing volatile goods inflation with strong, steady services inflation is not reassuring.
The CPI Services number has dropped from a recent high of 7.2% in January 2023, but it is holding Core CPI far away from the Fed’s 2.0% target.
The question haunting monetary policymakers is: How long can Core CPI inflation stay above 5.0% before the public starts expecting inflation to remain above 5.0%? If inflationary expectations do creep up in that way, it will make the task of beating inflation out of the system significantly more difficult. And more painful.
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This week look at U.S. goods imports in the two-plus years since the U.S. let preferential tariffs for developing countries expire and, contrary to expectations, found they actually increased.
For the second quarter in a row, the UK showed real GDP growth, at least according to the first estimate just released, which put growth at 0.1%. The overall economy is still 0.5% below its pre-covid (Q4 2019) size. The Q1 growth was largely driven by information technology and construction while various labor strikes caused contractions in key sectors, like education and public administration.
The Michigan Consumer Sentiment Index saw a significant month-on-month drop in May, falling 9.1%. The measure of year-ahead expectations for the economy was down 23% by the same measure, suggesting increasing concern about a recession.
U.S. wholesale inventories were down 2.1% month-on-month in March, following revisions to the February figures and down 2.9% year-on-year, with March 2022 levels having also been revised.
Weekly initial U.S. jobless claims increased by 22,000 from the previous week to 264,000, the highest level since the last week of October 2021. This was read by some as indicative of a cooling labor market. We wrote in May 8th’s Weekly Economic Report why other, slightly older labor market signals looked much stronger.
Last week’s major trade data releases again showed reasons for both optimism and concern:
China’s exports in U.S. dollars fell 6.4% month-on-month in April but were still up 8.5% year-on-year at $294.5 billion. Exports of ‘High-tech products,’ which includes LCDs and semiconductors, were down 6.6% through April compared to the same period last year. Exports to the U.S. were 7.5% smaller by the same measure; they were up by 3.2% to the EU, however, and up by 24.1% to ASEAN, China’s largest trading partner.
UK trade figures for March showed a month-on-month weakening of goods trade with non-EU countries, while imports from the EU remained stable. The value of overall real goods exports decreased 2.7% and goods imports by 2.8%. The fall in non-EU imports was driven mainly by a decline in fuels.
Mexico’s light vehicle exports grew 5.0% year-on-year in April to reach 253,335 units. It was the fourth straight month of increases. Exports to the U.S. through the first four months of the year are 6.7% above 2022 levels.
Taiwan April exports contracted 13.3% year-on-year, the seventh consecutive month of declines. Although down everywhere, exports to the EU-27 fell by the least month-on-month at 1.4%, while exports to North America were down 11.3%. Exports of electronics parts were down 15.1% through the first four months.
The Bank of England raised its benchmark lending rate 25bps to 4.5% last week, following similar moves by the Fed and the ECB a week prior. The Bank’s forward guidance is for the Bank Rate to peak around 4.75% in Q3 this year based on current projections for domestic growth, inflation and labor market conditions.
The Congressional Budget Office’s (CBO) [Updated Budget Outlook](https://www.cbo.gov/publication/59096) projects a deficit of $1.5 trillion this year, $100 billion higher than the February projection. The CBO cited revenue collection shortfalls as one reason for the upward revision, as well as ‘uncertainty’ surrounding the outcome of a pending Supreme Court case about the cancellation of student debt, among other factors. The cumulative deficit projection between 2024 - 33 stands at $20.2 trillion.
G7 finance ministers and central bank governors met in Japan last week to discuss the state of the global economy, among other issues, ahead of the G7 leaders meeting this week, also in Japan. Besides reiterating support for Ukraine, the ministers’ joint statement addressed the issue of supply chain resilience while also “preserving economic efficiency by upholding the free, fair, and rules-based multilateral system.”
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