Chart of the week: Big drop in US inflation

US CPI inflation data for April showed that headline CPI inflation fell to 1.1% – the lowest since 2010. Combined with already very weak Personal Consumption Expenditure price inflation data for March, this presents a very weak inflation picture for the US economy.

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The FOMC’s targeted measure of inflation is the Personal Consumption Expenditures (PCE), rather than the Consumer Price Index (CPI). As our charts show, PCE inflation tends to lie below CPI inflation. The difference reflects a combination of: formula effects, with only PCE chain-linked; different coverage; and a number of other computational differences.

Inflation as measured by the PCE price index stood at 1.0% in March. The sharp drop in the more timely CPI measure in April was driven by falling gasoline prices. Motor fuel prices fell by 8.2% in the twelve-months to April, contributing -0.4 percentage points to headline CPI inflation. Core CPI inflation, which strips out volatile energy and food prices, also fell. Core prices rose by 1.7% in the twelve-months to April, from 1.9% in March. This marks the lowest reading since June 2011. Core inflation as measured by the PCE price index stood at 1.1% in March.

Headline CPI inflation tends to be more volatile in the US than in either the UK or Europe because of the smaller tax element, and correspondingly greater degree of pass-through from changes in crude oil prices to pump prices. To illustrate, we estimate that a $10 increase in the price of a barrel of oil would add around 0.6 percentage points to US CPI inflation, but just 0.2 percentage points to CPI inflation in the in the UK and the euro area.

We see few signs of upward pressure on US inflation over the coming months. Although base effects mean that headline CPI inflation could prove to be erratic from one month to the next, we see it averaging something close to 1.5% for the remainder of this year, with the key PCE measure closer to 1.0%. US breakeven rates have fallen significantly in recent months, with the five-year measure dropping almost 40 basis points since the beginning of February to a little under 2.0%. This might raise concerns about deflation in the minds of some FOMC members. With a benign inflation backdrop, the Fed has plenty of room for manoeuvre.

 
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