April CPI: The Disinflationary Trend Remains Intact

The April CPI highlights dramatically the reality that the nearly two-year old disinflationary dynamic remains very much in place. Although the 0.1% decline in the overall index can be summarily brushed aside as the direct effect of noise related to energy prices for the month (-1.4%), the impressive part of the report is the behavior of the core component, which was flat in April. A 0.1% drop in the key housing category (42% of the overall CPI) and another sizable decline in apparel prices (-0.7%) were instrumental in producing the flat reading in the core index last month.

In fact, the core CPI has remained essentially flat in the last three months and is now up only 0.9% on a year-on-year basis. Putting it in a context, the series has now dipped below its year-on-year gain recorded in the prior distinct disinflation episode in the 2002-03 period, where it never fell below 1%.

The ongoing downtrend in core CPI in recent months is hardly surprising, given the very nature of inflation as a lagging indicator and the enormous amount of slack that has resulted from the severity of the 2007-09 recession. Despite the credible economic recovery under way, it is inconceivable to imagine any negotiating power by labor that would put any upward pressure on wages and salaries (and, by extension, the "services" part of the CPI that accounts for 60% of the index). Moreover, any increase in production costs associated with the rising commodity prices recently is quickly absorbed by manufacturers and retailers in the form of narrower profit margins.

On that score, it is telling of the near uniform absence of even a hint of upward price pressures that both the "services" and "commodities, ex. food and energy" parts of the CPI have been up by only 0.8% and 1.2% respectively from a year ago.

At the very minimum, the April CPI data continue to provide ample room for the Fed to delay the timing of implementing the process of rate hikes, until the economic recovery has picked up enough momentum and the absorption of the current slack is well under way. Despite any possible changes in the language of the FOMC statement over the next couple of meetings in relation to the "extended period" part, the working assumption should remain that any rate hike by the Fed prior to the end of the year is a very low probability outcome.

Anthony Karydakis