Energy Prices Push CPI Higher

The Consumer Price Index (CPI) rose by 0.2% in December, slightly below expectations and November’s 0.3%. Compared to December of last year, however, CPI rose by 2.3%, which is the warmest inflation figure since October 2018. The biggest driver of the monthly change in inflation continues to be energy prices, which are often a volatile measure. Fortunately, energy prices have not moved as much as expected while the current situation in the Middle East plays out. This is something energy markets are watching closely.

The core measure of CPI, which strips out food and energy prices, edged up to 0.1% in December with a yearly growth rate of 2.3%. Health care costs continue to move higher; December was the third straight month of 5.1% medical care service inflation on a year-over-year basis, the highest since August 2016. The highest-on-record monthly jump in prescription drug costs was staggering; it was the largest contributor to overall inflation during the month outside of energy.

Shelter costs, which include rent and owner equivalent rent, moderated slightly to a 3.2% annual pace, or a 0.2% month-over-month pace. Rental and housing prices have been climbing due to the low supply for entry-level housing in the hottest markets in the country. Builders have been focused on the higher-end housing and rental markets but finally switched course halfway through 2019. We expect the growth in prices to slowly taper off at the end of 2020.

Apparel prices fell by a 1.2% annual rate in December, capturing the short holiday season and the heavy discounting retailers offered in order to compete. Store closures exacerbated those discounts, with even luxury retailers affected by the deep discounts offered at Barneys. On the flip side, airline fares continued to climb for a sixth straight month after falling for the last five years. The grounding of the Boeing 737 Max has caused airlines to raise prices and reduce the number of flights.

Bottom Line
Upside risks to prices at the beginning of 2020 continue to be energy and health care costs. While the Federal Reserve monitors these measures closely, it is the Personal Consumption Expenditures (PCE) Index that it uses for the 2% inflation target; CPI tends to run hotter but even this suggests the Fed will continue to watch from the sidelines.

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