Federal Reserve poised for December rate rise

Headline consumer price index (CPI) inflation rose 0.5% last month to 2.2% year-on-year (y/y), according to data released today (Friday 13 October). Half the month-on-month (m/m) rise was due to higher gasoline prices linked to refinery disruption from Hurricane Harvey.

However, stripping energy and food out of the calculation, core CPI remained subdued at 1.7% y/y, a smaller increase than expected. Weakness in prices for housing, medical care and new vehicles weighed on the core rate.

Policymakers at the Federal Reserve (Fed) have debated the soft readings for core inflation and will probably still be puzzled by today’s reading.

Nonetheless, they will be reassured by a rebound in retail sales which rose 1.6% m/m in September. Some of this was related to the rise in auto sales as drivers started to replace the 300,000 plus vehicles lost in recent storms and floods. Such events provide a one-off boost to demand and will fade just as gasoline prices are now reversing.

Overall though, it indicates that price weakness is not associated with falling consumer demand and will encourage the Fed to continue with its normalisation process in December.

We had previously expected the Fed to put more weight on low inflation and to skip another rate rise this year; however, Fed chair Janet Yellen made it clear in a recent speech that she would look through the recent low inflation readings and continue to tighten policy if the data permitted. Today’s figures for inflation and retail sales show an economy with healthy demand growth.