Just when everybody was getting on board with the idea that U.S. inflation rates were finally rising back to a normal 2% to 2.5% pace (and thereby pushing the Federal Reserve to keep raising interest rates), the government dropped a bombshell of a report on Friday, showing that the consumer price index fell 0.3% in March, while the core rate that’s much less volatile fell 0.1%, the first drop in seven years and the largest decline in 34 years..
What happened? Will the sudden disappearance of inflation keep the Fed from raising interest rates?
First off, let’s dig into the details of the CPI report to figure out where the inflation wasn’t.
The main reason for the drop in the headline CPI was the usual suspect: gasoline prices. As everyone knows, gas prices jump around a lot. They are up 20% in the past year, but fell 6.2% in March. That one item accounted for 0.2 percentage points of the 0.3 percentage point drop in the CPI in March.
Because energy prices fluctuate so much on a monthly or even daily basis and because the Fed is trying to stabilize inflation over the longer run, Fed officials try to ignore the short-term ups and downs of gas prices when it comes to setting policy.
Which means it’s unlikely that the big drop in gas prices will change Janet Yellen’s mind about raising rates in June.
But what about the drop in the core rate, which historically has been the best gauge of where inflation is heading in the long run. Did the drop in March signal a new disinflationary trend?
Yes and no. Much of the decline in March was due to what economists call “one-off factors.” For instance, hotel and motel prices fell 2.4%, while apparel prices fell 0.7% after rising sharply in January and February. The other big decliner in March was cell phone service, which fell 7%, accounting for another 0.1 percentage point of the decline in the CPI.
These are likely blips that won’t persist.
But something else is going on that was hidden by those “one-off” declines in March: Housing prices are not rising nearly as fast now as they were last year.
That’s a huge deal, because the cost of renting or owning a home accounts for a third of the CPI’s basket of goods and services. It’s by far the largest expenditure in almost everyone’s budget.
In March, the cost of owning a home rose at about half the rate it rose in December. Over the past three months, ownership costs are rising at a 2.7% annual rate, compared with 3.7% in the three months ending in December.
Similarly, the cost of renting an apartment or home has risen at a 3.4% annual rate in the first three months of the year, compared with a 4.3% pace in the last three months of 2016.
This could be the start of a new trend of more moderate housing cost increases. Earlier in the week, economists at Goldman Sachs argued that the supply of housing — particularly apartments — was finally catching up with demand. Which means rents won’t rise as fast as they have been.
This doesn’t mean, of course, that we’ll continue to see declines in the CPI and the core CPI month after month. With the economy near full employment, effective demand will probably be strong enough to create some inflationary pressures in the economy.
But the moderation in housing costs probably means that the Fed needn’t fear a large overshoot of its inflation target. The prospect that the Fed will need to quicken the pace of rate hikes has lessened.
All because the rent ain’t quite so damn high.