Thank goodness for core!
For those intent on staying positive on the future path of inflation, focusing like a laser beam on the so-called core rate of the consumer price index is essential to one’s mental health.
This morning’s report on CPI offers a potent example. On the surface, there’s bad news: top-line CPI rose 0.7% last month, the highest since September 2005’s anomalous 1.2% surge. As a result, CPI’s annual pace as of May is a worrisome 2.7%. More troubling than the absolute level is the trend. Since late last year, CPI’s annual rate of change has been climbing. As recently as last October, annual CPI was a mere 1.3%–lower by more than half compared with the current inflation.
But optimism has a savior in the core CPI reading, which extracts the troublesome energy and food prices from the mix. By that standard, all’s well. In a bubble universe where no one buys energy and food, inflation is barely worth a mention. The 0.1% rise in core CPI last month was lower than April’s 0.2%. In fact, the annual change in core CPI through May is notable mainly for its descent over time. For the fourth month running, the 12-month change in core CPI has fallen, posting just 2.3% for May, down from 2.9% in September 2006.
The question then becomes: which one speaks the truth? The answer depends on one’s perspective. Indeed, the central bank has a fondness for the core reading because it conveniently strips out the biggest pricing variable over which the Fed has no control: energy. True, of course, and so there’s a case to be made for central banks focusing on core. The hope, and it’s not entirely unjustified, is that the Fed can excute a prudent monetary policy by ignoring food and energy prices. If so, the benefits will eventually flow to the economy overall. By that standard, we can all rest easy.