January 10, 2023
(The monthly Consumer Price Index (CPI) is scheduled for release by the Bureau of Labor Statistics on Thursday, January 12th at 8:30 AM Eastern Time.)
The overall inflation rate in November was just 0.1 percent, held down by a 2.0 percent drop in gas prices. However, inflation in the core index was also moderate, coming in at just 0.2 percent. Major factors holding down the core index in the month were a 2.9 percent drop in used vehicle prices and a 0.7 percent decline in the price of medical services. These sharp declines are not likely to be repeated, so we are likely to see a somewhat worse picture in the core index in December, although another sharp drop in gas prices should ensure the overall inflation rate is again below 0.2 percent.
The Fed has indicated that inflation in non-housing services is a major concern in setting interest rates. The logic is that these prices are largely driven by wages. At the start of the year, wages were growing at more than a 6 percent annual rate. The pace had slowed to around 5 percent by the summer.
In the most recent three-month period, as a result of slower growth in December and a sharp downward revision to the November data, wages were growing at just over a 4 percent annual rate. If the December data are not subsequently revised upward, and remain consistent with other wage series, it will mean considerably less price pressure going forward in non-housing services.
The link between wage growth and prices in non-housing services is actually not all that tight. For example, the price of transportation services, which account for a large chunk of this category, are driven to an important extent by goods inputs. In the case of car repair and auto insurance, the price of car parts is a major factor, which had soared during the pandemic due to supply chain problems. Airfares depend to a substantial extent on the price of fuel.
But categories like medical services, excluding insurance, are likely driven to a substantial extent by wages. The story here has actually been reasonably good in recent months. The index for professional medical services rose just 0.1 percent in November after rising 0.2 percent in October. It is up by just 3.1 percent over the last year. The index for hospital and related services fell in both October and November, dropping by 0.2 and 0.3 percent, respectively. It is up 3.2 percent year over year.
We may see somewhat more inflation in these components in December, but the overall picture here is surprisingly good. Transportation services also showed a good picture in November, dropping 0.1 percent, driven largely by a 3 percent decline in airfares. This is not likely to be repeated in December, but we are likely to see a better picture with the auto repair index, which rose 1.3 percent in November and auto insurance index, which increased by 0.9 percent. With these items showing slower inflation, the rise in the larger transportation index should be in the 0.2–0.3 percent range.
Further Price Declines in Supply Chain Items
In recent months, the prices of many of the items that had pushed inflation higher in 2021 and 2022 have trended downward. Nonetheless, many categories still have a substantial distance to go before being back near pre-pandemic trends. The price of household furniture fell 0.8 percent in November, but is still 6.8 percent above its level a year ago. The appliance index rose 0.9 percent after falling the prior four months and in six of the last seven. It is still 13.7 percent above its pre-pandemic level and likely has further room to drop. Apparel prices rose 0.2 percent in November after dropping the prior two months. They are 3.6 percent above their year ago level and likely also have some room to drop further.
Will Rental Inflation Begin to Slow?
We know from private indexes of marketed units that rental inflation in the CPI will soon begin to slow, but it is not clear how quickly the slower rental inflation, or even deflation, in marketed units will show up in the CPI, which measures rents in all units.
Rent is of course a huge factor in inflation. The two rental indexes account for 31 percent of the overall index and almost 40 percent of the core index. The index for rent of a primary residence rose 0.8 percent in November, while the owners’ equivalent rent index rose 0.7 percent. Each was 0.1 percentage point higher than the October increase, although this was largely due to rounding. There may be some modest slowing in rental inflation in December, but we will likely have to wait until spring for rental inflation to be back near pre-pandemic rates.
New and Used Vehicles
New car prices were flat in November after rising consistently throughout 2021 and 2022. They are more than 20 percent above their pre-pandemic level. As noted earlier, used vehicle prices fell by 2.9 percent in November, but are still 42.6 percent above their February 2020 level. Both items have considerable room to fall further, with at least some of the decline likely to show up in December.
Food prices continue to be a major factor in inflation. The food-at-home category rose 0.5 percent in November, it is up 12 percent over the last year. We are seeing sharp increases in a wide range of foods. Bakery and cereal prices have risen 16.4 percent over the last year. Chicken prices are up 12 percent and milk prices have risen by 14.7 percent.
Earlier in the recovery it was possible to explain these sharp hikes by higher shipping costs, but with these costs now getting close to pre-pandemic levels, that explanation is no longer plausible. Bad weather has clearly been a factor, but it’s not clear it explains sharp price increases across such a wide range of items. Interestingly, beef prices have been falling in recent months and are now down 5.2 percent from their year-ago level.
The price of restaurant food has not risen as rapidly as store-bought food, increasing just 8.5 percent over the last year. This indicates that higher wages in the industry have not been a big factor pushing up prices.
Inflation Looks to be Slowing but Uncertainty Remains
We have seen good news on inflation in many sectors, most notably the reversal of many of the price jumps caused by supply chain problems. We also know that rental inflation in the CPI will soon slow sharply, based on data from private indexes.
The biggest cause of ongoing concern is that wages may be rising too rapidly to be consistent with acceptable rates of inflation. The December jobs report was very positive on this point. Wages increased at just a 4.1 percent annual rate over the last three months, down from 6 percent at the start of 2022. It also looks like productivity growth will be strong for the fourth quarter. Slower wage growth and faster productivity growth should dampen inflation in 2023.