US finds temporary inflation relief
US inflation surprised to the downside today with the consumer price index (CPI) rising less than expected in September. The annual rate fell from 2.7% to 2.3% y/y. Much of this decline was due to the effect of last year’s increase in energy prices dropping out of the index; if we exclude food and energy the core CPI rate was stable at 2.2% y/y. Nonetheless, this was also lower than expected with the weakness concentrated in prices for used vehicles.
When combined with last month’s weaker reading, investors are asking whether we have seen the peak in inflation for this cycle. The base effects will weigh on annual CPI rates for another month or so; however, the core rate is expected to move higher.
Our inflation model predicts a further rise in core CPI as the lagged effects of stronger economic activity push prices higher. Inflation responds to activity with long lags such that next year’s prices are significantly influenced by this year’s activity. The tight labour market also contributes and higher underlying inflation is typical for an economy facing increasing capacity constraints and generating wage pressure. When combined with the estimated effect of tariffs, we expect the core inflation rate to be running above 2.5% through 2019.
Consequently, we see today’s figures as only providing temporary relief on the inflation front and believe it is too early to anticipate the turn in the inflation and interest cycle.