CPI Treads Water in July

The Consumer Price Index (CPI) edged up 0.1% in July from June, with widespread declines in energy prices offsetting a larger-than-expected uptick in food prices. Grocers and restaurants raised prices, attempting to tap into the discretionary spending that lower prices at the pump will hopefully bring. So far, however, increases in food prices have proven short-lived, as middle- and low-income households both need and expect bigger discounts, especially at fast-food and family style restaurants. High-end restaurants have done better on the heels of stronger profits and more lavish corporate outings.

Transportation also showed a large drop in price as airfares receded fairly sharply. It seems that people were more willing to drive to take a vacation than fly in July, given the drop in prices at the pump. If the Harbor Country of Michigan is any indicator, the short drive to vacation spots is stronger than I have seen in years, with summer rentals booked almost solid and restaurants full.

Separately, medical services and prescription drug costs continued to moderate after a spurt earlier this year; this is a trend that is likely to continue even as more people regain employment and get access to insurance. Much more of the cost of medical care is being shouldered by individuals even when they do have insurance, which makes them much more cautious about how they consume that care.

Used car prices fell, which bodes poorly for trade-in values and could be a bit of an obstacle to new vehicle sales this fall. Look for financing incentives to be sweetened. Apparel prices were higher and sold well at specialty clothing retailers in July. A drop in birth rates since 2008 is expected to take a toll on back-to-school spending again in August and September, which is likely to trigger another round of discounts. The number of kindergartners entering school has fallen precipitously over the last two years.

Bottom Line: The CPI rose 2% from a year ago in July, which means that the porridge is still too cold for Federal Reserve Chair Janet Yellen. The Federal Open Market Committee (FOMC) targets the more accurate PCE index at 2%, which runs about one-half percent cooler than the CPI. This means that the Fed isn’t going to worry much about inflation until the CPI approaches 2.5%. Even then, there is wiggle room, as FOMC members have indicated that they are willing to tolerate inflation a little above-target if it gains us more in labor market healing, given the fact that we have been running a little cool on inflation for a while.

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