Today’s update on consumer prices for September looks like a poster child for biopolar disorder.
On the one hand, top-line inflation is conspicuous in its absence. Consumer prices actually dropped last month, posting a sizable -0.5% loss for September. Monthly plummets of this magnitude are rare for CPI, with only a handful arriving in the past generation on a month-to-month basis. But while top line inflation has, for the moment, vanished, core inflation (which excludes the volatile food and energy sectors) shows every indication of staying put.
Core consumer prices rose 0.2% last month, matching the pace in the previous two months. More ominously, the annual rate of core prices edged up to 2.9% in September vs. the year-earlier month, up from 2.8% in August. In short, core inflation is now running at the highest annual rate since 1996, as the graph below shows.
STILL CLIMBING
Rolling 12-month % change in core CPI

Source: Bureau of Labor Statistics
The reason for the divergence between top-line and core prices is an energy story. The sharp correction in oil and gasoline prices last month dragged down the broad CPI index. Energy prices dropped a hefty -7.2% last month, a tumble that helped pare transportation prices by -4.1% in September.
Alas, this kind of relief is probably as ephemeral as political promises in an election year. Energy prices have suffered big corrections relative to past months, but at some point a price floor will be reached, and we’re a lot closer to that floor today than we were a month or two back. Anything’s possible in the 21st century, but $20-a-barrel-oil exists at the outer edge of possibilities.
The inflation problem, in other words, isn’t going away. With core CPI continuing to inch higher, the Fed needs to prove that it can control price momentum. So far, that proof is lacking. Declining energy prices are no substitute for muscular monetary policy. For the moment, the distinction is lost on Mr. Market. But if core CPI continues to creep up in coming months, the markets will be forced to reprice risk.
The dilemma, of course, is that getting tough with inflation is risky at this point in the economic cycle. If the economy continues to slow, Bernanke and company will be faced with the thankless task of choosing between containing inflation and keeping the economy bubbling. It’s been said that central banks can have both, simultaneously. The record, however, is mixed, at best.
Mr. Bernanke’s big adventure has only just begun. The consensus believes that he’ll be able to pull a monetary rabbit out of the hat. Giving him the benefit of the doubt has been easy of late, thanks to declining energy prices. When that support fades, as it soon will, the crowd is likely to become less forgiving. The clock is ticking.