Inflation Highest in a Year

The Consumer Price Index (CPI) moved up 0.3% in November, largely in response to higher energy prices. That pushed year-over-year measures of overall inflation to 2.1%, the warmest pace in a year. Overall energy prices are still much lower than a year ago, which should provide an extra boost to holiday spending, which fell apart last year.

The core CPI (excluding food and energy) rose 0.2% during the month and slipped to a 2.3% pace on a year-over-year basis. Medical services, which have been a major driver of core inflation this year, moderated slightly but remained 5.1% above levels one year ago. This is especially hard for older households, which tend to spend more of their consumer budgets on medical care. This is also showing up in hiring in the health care sector, one of the few categories that is up from the pace of 2018.

Separately, shelter costs remained a driver of overall inflation. Lodging away from home - mostly hotels - was a primary driver of those gains. Stronger-than-usual travel during the Thanksgiving holiday likely pushed up prices for hotel rooms, which suffered earlier this year from a shift downscale and the increased competition from Airbnb. Rents and home prices also continued to move up but not as rapidly as we saw earlier in the year; prices are already extremely high in the hottest job markets.

The CPI tends to run hotter than the Federal Reserve’s preferred target for consumer inflation, the Personal Consumption Expenditures (PCE) index. One reason is that measures for medical costs do not include many of the co-payments associated with insurance, which has slowed the upward shift in medical costs in recent years. Another reason the PCE tends to run cooler than CPI measures is that the PCE better captures the tradeoffs that consumers make in the relative prices of goods and services; e.g., they buy more rice and beans, if the price of meat surges, to help keep their grocery bills in check.

The CPI underscores a challenge for the Fed in 2020. It appears that inflation will continue to fall short of the target on PCE inflation as members of the Federal Open Market Committee (FOMC) weigh their decision on whether to cut short-term interest rates today. We expect them to remain on the sidelines for now, then cut again in 2020 or lower the target on inflation, which is less likely. The Fed is trying to avoid the low inflation, slow-growth trap that Japan is in. Demographics are starting to turn against it, with retirements by the baby boom accelerating.

Bottom Line
Consumer inflation moved up on higher energy prices but remains more than well contained overall. The problem is the composition of increases for some households. Our growing ranks of older households are struggling with medical costs.

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