Pointing out headline inflation’s ascent of recent years has been a fruitless exercise in swaying opinion. The rise of annualized rate of increase in the monthly consumer price index had in September and October climbed above 4% for the first time in more than a decade. But the jump was effectively dismissed as largely irrelevant, the byproduct of the energy bull market of late and therefore unworthy of serious consideration as a sign that inflation threatened. Or so many reasoned.

The real action was in the core rate of inflation, otherwise celebrated as the true gauge of pricing trends. On that score, core depicted an inflation that was well-mannered, docile and generally unthreatening, delivering a sharp and soothing contrast to headline CPI’s rude message.
There was no smoking gun in yesterday’s report to materially change that view, at least when looking at the numbers. Core CPI (less food and energy) rose by 0.2% in November, unchanged from October’s advance. On an annual basis, core inflation increased by 2.1%, also unchanged from the 12-month rate of advance logged in October.
Meanwhile, just for fun, headline inflation last month literally collapsed, thanks to falling energy prices. True, no one should expect that will continue. Still, even if it’s a one-time event, the biggest monthly drop in CPI in more than 50 years isn’t chopped liver.
But just when you thought the market would celebrate such a milestone, persistent or not, Mr. Market decides that it’s time to start worrying about core inflation after all. The bond market registered its anxiety yesterday by moving the 10-year Treasury yield back above 4.5% at one point in the day before closing the session at around 4.47%. Fairly quiet stuff, to be sure, when it comes to bond trading, although the fact that the benchmark 10-year’s yield didn’t move much on a once-in-50-year-drop in monthly CPI tells you something.
The stock market, on the other hand, wasn’t nearly as restrained. The S&P 500 shed 1.8% on Thursday. The buzz is that yesterday’s industrial production report for November from the Fed reminds that the economy continues to bubble, keeping the inflationary fires smoldering. Industrial production advanced 0.7% last month, following a revised hike of 1.7% in October. Meanwhile, capacity utilization crept higher too, moving above the 80% mark for the fifth time this year. To the extent that the bond market thought sluggish industrial activity would help keep a lid on core CPI, such wishful thinking looks increasingly outdated.
“The manufacturing sector seems to be on the rebound, recovering much of the loss suffered during the hurricanes,” Lynn Reaser, chief economist of the Investment Strategies Group at Bank of America in Boston, told Bloomberg News yesterday. “The overall economy is approaching a fuller level of capacity, both in terms of the labor market and in our industrial sector.”
Perhaps that’s not reason to worry, but combined with a core rate of inflation that seems inclined to inch higher has inspired some to start worrying. “While this rate of ‘core’ consumer price inflation remains very low by historical standards, it is still roughly double the inflation rate of 2003 of 1.1 percent,” said Brian Wesbury at Claymore Securities, via a story posted on Political Gateway yesterday. “While somewhat slow and unsteady, the acceleration in inflation is very real … as 2006 unfolds we look for the ‘core’ CPI to push toward a 3.0 percent rate of increase.”
What’s so disturbing about a core rate that’s running at 2.1% a year? Indeed, as Wesbury noted, it’s up from the low-1% range that prevailed in 2003. No big deal, perhaps, although the upward trend is obvious. But perhaps more importantly, a 2.1% rate of increase is now slightly above the 1%-to-2% range for core inflation previously championed by Ben Bernanke, who’ll take over the Fed from Alan Greenspan on January 31, 2006.
The new new game with inflation has become watching core CPI, and watching closely. It’s already above Ben’s comfort zone, and that’s no aberrant trend. Core CPI’s annual rate of change has been at or above 2.0% each and every month in 2005. The only question is what will Ben do, and when will he do it? Perhaps we’ll hear the argument that the core CPI doesn’t really reflect the “true” rate of inflation. Regardless, rest assured that helicopter references, as they relate to monetary policy, won’t be returning any time soon.