October 11, 2022
(The monthly Consumer Price Index (CPI) is scheduled for release by the Bureau of Labor Statistics on Thursday, October 13th at 8:30 AM Eastern Time.)
The overall CPI increased just 0.1 percent in August after being flat in July. In both months the overall inflation rate was held down by sharp drops in gas prices. We are likely to see another good overall CPI number, even if the core index will still be higher than the Fed wants.
Substantial Inflation in Rental Indexes Likely to Continue
The two rental components of the CPI, rent proper and owners’ equivalent rent, account for 31 percent of the overall CPI and almost 40 percent of the core index. This means that CPI inflation will be high as long as these indexes show high inflation.
Both indexes showed 0.7 percent inflation in August and are up 6.7 percent and 6.3 percent over the last year, respectively. There is evidence that the housing market is cooling rapidly.
Measures of new and existing home sales are both down by close to 20 percent from year-ago levels. The feedback from the sale market to the rental market is indirect, but it does appear that the rate of household formation has fallen sharply from 2021.
It seems that many people moved out from living with family or friends last year, effectively eliminating a backlog of people in this situation. A study from the San Francisco Fed indicates that the switch to working from home was responsible for the bulk of the increase in housing inflation in the pandemic recovery, as people working from home needed more space. While work from home may continue to increase, it will be at a far more modest pace, so it will not have as much effect on prices and rent. Several private indexes also show slower rental inflation or even declines in some areas.
Nonetheless, the rental index has considerable inertia caused by its construction. Half of its sample is composed of leases signed six months ago. This means that the September index will reflect the inflation rate in leases signed in March, when rental inflation was peaking in private indexes. This means that, at best, we will see a modest drop in rental inflation, perhaps by 0.1 percentage point, which means that core inflation is likely to be elevated again in September.
Vehicle Prices May Show Declines
Both used and new vehicle prices have soared since the pandemic, driven largely by the shortage of semiconductors due to a fire in a semiconductor plant. Manufacturers are overcoming the shortage with production near pre-pandemic levels, but there is still a considerable backlog of demand.
Used vehicle prices have been dropping in private indexes throughout the year. The used vehicle index fell 0.1 percent in August but is still up more than 50 percent from its pre-pandemic level. The new vehicle index rose by 0.8 percent in August. It is up by 18.8 percent from its February 2020 level. The new vehicle price will likely show a smaller increase in September and possibly decline after its sharp August rise. However, it is not clear that we have reached a clear turning point in the car market.
Household Items May Show Price Declines
Many household items, like furniture and appliances, which typically show flat or declining prices, had sharp price increases in the pandemic recovery. With the supply chain issues we saw earlier in the year largely resolved, we should see flat and or declining prices for many of these items.
We are seeing this clearly with appliance prices, which fell 1.6 percent in August, after dropping 0.6 percent in July. We are likely to see further price declines through the fall. However, furniture prices rose 0.5 percent in August after rising 0.9 percent and 1.1 percent in the prior two months. Apparel prices rose 0.2 percent in August and are up 5.1 percent over the last year. These indexes will turn around, although declines may not show up yet in the September report.
Medical Care Service
Inflation in medical care services had been reasonably well contained through last year but picked up markedly in 2022. The biggest factor in this uptick has been the insurance component, which has been rising at a rate of more than 2.0 percent since the start of the year, after falling through most of 2021. This component, which measures administrative costs and profits, not premiums, may again reverse course due to changes in payment structures.
Food prices have been a major factor driving the overall inflation rate and are also a very visible item to consumers contending with inflation. The food at home index rose 0.7 percent in August and is up 13.5 percent over the last year.
There is reason to believe that we will see a better picture in September. The prices of many underlying commodities, such as wheat and corn, have fallen sharply from peaks earlier in the year. Shipping costs, a major factor in food prices, have fallen back to more normal levels, although still elevated compared to pre-pandemic averages. It is likely that the rate of inflation in food will at least moderate in September.
Core vs. Overall
The September CPI will be the last release before the election. This will create an interesting split picture. The Fed will focus on the core index in making a call on interest rate hikes. The high rental inflation of six months ago will be a major factor pushing the core higher, even if many supply chain problem areas may be showing substantial improvements.
However, food and gas prices will be important in people’s assessments of the economy as they go to vote. We know gas prices will show some drop in September, although not as much as in July and August. There is reason to believe that food price inflation will moderate, which would be a positive picture for many voters.