What Does the Recent Decline in CPI Mean for the US Economy?

The latest Consumer Price Index (CPI) report shows that inflation continued to cool off in May, providing a much-needed relief to Americans who have been struggling with two years of rising costs. According to the Labor Department’s latest report, consumer prices increased by 4% from a year earlier, down from 4.9% in April. The annual increase was the smallest since March 2021. Although overall prices rose only 0.1% in May, core prices – which exclude volatile food and energy items – rose 0.4% for the third straight month. The decrease in consumer prices was largely driven by a fall in gas prices and softer increases in grocery prices.

What is CPI and What is Core CPI?

CPI is an inflation gauge prepared by the Bureau of Labor Statistics each month. It measures the average change over time of what urban consumers pay for a market basket of consumer goods and services. There are two main parts of CPI: the headline CPI and core CPI, which excludes the volatile energy and food sectors. While the core measure may give a more accurate reading of where inflation is headed over the short term, headline inflation more accurately represents people’s actual expenses, according to the Cleveland Federal Reserve.

Implications for the Fed Policy

The report presents a quandary for a Federal Reserve that’s expected to pause its 14-month campaign of aggressive interest rate hikes aimed at corralling inflation. While price increases broadly have eased, the Fed is more concerned about stubbornly elevated core inflation. As a result, some Fed officials have said they were leaning toward skipping a rate increase this week but hiking again in July. However, economist Jason Schenker of Prestige Economics believes that overall price increases slowed so substantially in May that the Fed will likely hold off further rate bumps this year.

Paul Ashworth of Capital Economics, on the other hand, expects the Fed to hike rates again in July, given the persistent core price gains. Regardless of the Fed’s decision, it is important to remember that inflation is a complex issue, and there is no easy fix. Fed Chair Jerome Powell has said that the central bank must embrace a “patiently accommodative” stance and not raise interest rates too quickly, which could prematurely derail the economic recovery.

Food and Gas Prices

Two of the biggest contributors to the recent inflation run-up – gas and grocery prices — are showing signs of softening. In May, grocery prices edged up just 0.1% after two straight declines, pushing down the yearly increase to 5.8% from 7.1%. Prices of commodities, such as wheat and corn, have fallen in recent months due to easing global demand. This has led to drops in prices of certain food items, such as eggs, which had increased sharply due to bird flu-related factors. Meat prices, however, continue to show some signs of volatility. While prices of bacon, fish and seafood, and fresh biscuits fell, bread prices rose, and chicken costs increased slightly.

Gas prices fell 5.6% in May and are down nearly 20% from a year earlier. Pump prices have remained relatively low due to lingering recession fears that have held down global oil demand and prices.

Outlook for Rent Prices

Rent continues to be the biggest driver of inflation, though the rate of increase has slowed somewhat. Rent picked up 0.5% for the third straight month; economists expect rent increases to ease substantially, based on new leases, but that shift has been slow to filter through to existing leases.

Conclusion

Overall, the latest CPI report suggests that inflation is starting to ease, but it is important to note that the Fed is more concerned about stubbornly elevated core inflation. The central bank must strike a delicate balance between tackling inflation and supporting the economic recovery. For American consumers, the cooling off of food and gas prices is a welcome relief. However, volatility in meat prices and the persistent rise in rent prices are two important factors that need to be monitored and addressed. Moving forward, the Fed’s decision on interest rates will be closely watched as the economy continues to recover from the pandemic.