- The jump in US core inflation has (understandably) got investors worried
- While the scale of the rise was indeed surprising, the details suggest that commodity prices, rather than the tight labour market, were the main driver
- Though anticipated, the more rapid pass-through of higher commodity prices poses upside risks to our 1.7% core CPI forecast for 2018
- However, we continue to expect core services inflation to remain well-behaved this year, given weak unit labour cost growth
Core CPI rose 0.35% mom unrounded in January – the biggest jump since October 2005. The upside surprise, which follows an acceleration in wage growth earlier in the month, has fuelled market concerns that we are on the verge of a sharp upswing in inflation spurred by the tight labour market. The details in the January inflation print do not support that conclusion, however. Indeed, a closer look reveals a number of unusual factors drove the surprise.
The biggest contribution came from core goods – in particular from apparel which saw the largest month-on-month rise since February 1990. Core goods has been a structural drag on inflation since the 1990s, likely reflecting globalisation and and technological progress, but we are now entering what is likely to be a short-lived period where that drag eases somewhat. Another major contributor relative to recent history was transportation. We think this reflects the lagged pass-through from higher gasoline prices over the past year or so.
Indeed, the impact of the pickup in commodity prices and the weaker dollar over the past 18 months on inflation is something we had anticipated (see our report here), though we did not expect it to come through quite so dramatically in a single month’s print. But while this does pose upside risks to our 1.7% core inflation forecast for 2018, our base case remains that it will take longer than many market participants are expecting for the tight labour market to exert serious upward pressure on inflation.
This is because, although wage growth is picking up, unit labour costs are not. Smoothing through the quarterly volatility in unit labour cost growth, they have been essentially flat over the past four quarters. This reflects a long-overdue recovery in productivity growth. Should that recovery in productivity growth continue, as in our base case (see here), the impact of accelerating wage growth on inflation is likely to remain muted in the near term.