January Brings Higher Inflation and Weaker Retail Sales

The January retail and inflation data paints a grimmer picture of the economy than we have seen in months.

The Consumer Price Index (CPI) rose 0.5% in January, after rising an upwardly revised 0.2% in December. A pickup in food and energy prices pushed the overall index up faster than expected. A colder-than-usual January, particularly in many Southern States and their use of heat likely contributed to those gains; some of the usual tourist spots were forced to temporarily close because of the harsh weather conditions. The overall CPI rose 2.1% from a year ago, slightly hotter than many in the financial markets expected.

The core (nonfood and energy) CPI rose 0.3%, also a bit hotter than markets were expecting, Gains were fairly broad-based with the exception of vehicle prices. The biggest upside surprise was a 1.7% monthly surge in apparel costs, which have been falling for years. Retailers were particularly aggressive about keeping their inventories low this year. That, coupled with a good holiday spending (though not quite as strong as first reported), contributed to the gains. I wouldn’t hold my breath that apparel prices are on the rise yet, given what retailers are telling me about online competition. The core CPI edged up to a 1.8% pace from one year ago, something the Federal Reserve will be watching closely.

Perhaps in response to higher prices, retail sales disappointed in January and were revised lower for the month of December. Total retail sales dropped 0.3% during the month, led by a 1.3% decline in vehicle sales. Building material sales also plummeted, which is likely more a reflection of the unusually harsh winter weather, most notably in the South, than a shift in demand. Retailers in the home repair and remodeling space have reported a major upswing in activity in recent months. Look for a big rebound, particularly in the building materials and supply category in the months to come.

Spending at clothing stores increased but not enough to offset the month’s price rise, a sure sign that those prices will come down again next month. The only other strong spot was spending online, which tends to do better when weather conditions are unusually bad; instead of going to the store, people shop from their couches.

Bottom Line
Today’s retail and inflation data painted a grimmer picture of the economy than we have seen in recent months, with inflation picking up and spending abating. Unusually harsh winter weather conditions contributed to those shifts. Moreover, they are in sharp contrast to what we are hearing from retailers, who claim spending was still good in January despite the weather interruptions. February may not deliver the rebound we would like partly because tax returns are coming in slower than usual, which will push many refunds into March from February when consumers typically see them. It has already proven to be a rough start of the year for financial markets. The data is not going to make it much easier in the weeks to come.

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