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Behind the Numbers: PCE Inflation Update, May 2011

This update, prepared by Dallas Fed Senior Economist Jim Dolmas, provides an in-depth analysis of the latest personal consumption expenditures (PCE) inflation data. Updates will be posted monthly, following the release of the official PCE data by the Bureau of Economic Analysis. NOTE: Terms in bold are defined in the Inflation Update Glossary.

As we guessed in last month’s Inflation Update, declines in the price of gasoline were a significant drag on the headline PCE inflation for May, subtracting about 1.1 annualized percentage points off the headline rate and pulling the headline rate below the core PCE inflation rate for the first time in nearly a year. The headline rate for May came in at an annualized 2.1 percent, compared with rates in the 4 to 5 percent range over the first four months of the year. The six-month headline rate inched up from 3.7 percent in April to 3.9 percent in May, while the 12-month rate increased from 2.2 percent to 2.5 percent.

What comes as a bit of a surprise in the latest release is the relatively robust growth in the core, or ex food and energy, index, which recorded a 3.1 percent annualized rate of increase in May, up from the neighborhood of 2 percent that the core had occupied over the prior four months.

Much of the strength in the core index, though, comes from movements in some of its more volatile components—especially prices for apparel, which alone contributed about 0.5 annualized percentage points to the May core rate, and prices for hotels and motels, which contributed nearly 0.3 annualized percentage points.

The trimmed mean, in contrast, paints a more stable picture, with May’s trimmed mean rate of annualized 2.0 percent actually down a tad from April’s 2.3 percent, but very much in line with every reading we’ve seen this year. For the year thus far, the trimmed mean has posted rates between annualized 1.8 and 2.3 percent and has averaged, almost exactly, an annualized 2.0 percent.

Regular readers of the Inflation Update know that we prefer the trimmed mean’s dispassionate exclusion of all the most volatile price changes to the core’s singular dismissal of food and energy prices. Consequently, from our perspective, we see no real jump in the underlying inflation trend with this month’s release—sifting the signal from the noise, the underlying trend remains around 2 percent.

Gasoline Prices a Drag That Will Likely Continue

Seasonally adjusted gasoline prices fell roughly 2.3 percent in May, a bit more than the 2 percent drop we predicted—using weekly retail price data from the Department of Energy—in last month’s Inflation Update.

We can expect an even larger drop when PCE data for June are released: Based on weekly data for the first three weeks of June, gasoline is tracking down roughly 6.1 percent compared with May. Those weekly data are not seasonally adjusted, and the typical seasonal pattern in gas prices calls for an increase in June in the range of 0.6 to 1.0 percent. This means that the seasonally adjusted price change—which is what’s relevant for the PCE release—should be in the neighborhood of –7.0 percent. That would be the largest one-month drop in the price index for gasoline since fourth quarter 2008.

Given gasoline’s weight in the PCE—just under 4 percent of consumer expenditure—a 7 percent drop in price would shave just under 0.3 monthly percentage points off next month’s headline rate. Barring another unusually strong set of price gains outside of gasoline, we expect June’s headline rate not only to be below the core rate for a second consecutive month, but to come in slightly negative as well.

And, given recent movements in crude oil prices—which have fallen about $10 per barrel from the end of May, with much of that decline in just the past week—the drag from gasoline prices is apt to continue beyond June’s data.

Food Price Inflation Moderates Very Slightly

The rate of increase in food prices moderated again, coming in at an annualized 4.1 percent, down from an annualized 5.4 percent in April and an average 9.5 percent over January, February and March. The moderation in the pace of food price increases over the past two months, compared with the prior three, owes a lot to the behavior of prices for less-processed food items, which tend to be volatile, and less informative about underlying trends in food price inflation. Over January–March, our price index for less-processed food items averaged an annualized 18.6 percent rate of increase, which fell to just a 2.2 percent rate over April and May.

The index for more-processed items items shows more continuity—and hence fewer signs of moderation. That index averaged an annualized 5.8 percent rate over the first three months of the year and has averaged a 5.5 percent rate the past two months.

Apparel, Vehicles, Lodging Swing the Core; the Trimmed Mean, Not So Much

May saw a second consecutive month of robust increases in the prices of core goods, which advanced at a roughly 3.7 percent annualized rate, after increasing at a 3.1 percent rate in April. As noted above, prices for apparel—clothing and footwear—were a key contributor, increasing at a 17 percent annualized rate in May. Vehicle prices—for both autos and trucks, new and used—also gave core goods prices a significant boost, contributing about a quarter of an annualized percentage point to the May core rate on the strength of a roughly 12 percent annualized rate of increase.

The rate of increase in prices for core services also picked up in May, coming in at a 2.9 percent annualized rate, compared with a 1.9 percent rate in April. The price index for lodging at hotels and motel was the single biggest contributor here, but air travel (up at a 17 percent annualized rate) was also a factor, as was the index for recreation services (up a stout annualized 5.3 percent).

Rent and owners’ equivalent rent (OER) both snapped strings of decelerating rates of growth in May. The price index for rent increased at a 1.4 percent annualized rate, up from 0.8 percent in April, and following five months of downward drift in its rate of increase. OER came in at an annualized 1.2 percent, up from 0.8 percent in April. Given the apparent tightness we see in rental markets, the slower and slower rates of rent growth we’d been seeing were somewhat puzzling. For one month, at least, we do not have to puzzle over that phenomenon again.

Among both core goods and services there were, of course, some hefty price declines as well—the index for miscellaneous personal care products fell at a roughly 12 percent annualized rate, while the index for commercial bank services fell at a roughly 18 percent rate.

The outsized price increases pretty clearly won the battle for the core over the outsized price decreases in May. The trimmed mean, which abstracts from both, points to continued underlying inflation at a rate around 2 percent. The six-month trimmed mean rate is in fact getting close to 2 percent, inching up to 1.9 percent from 1.7 percent in April.

Number of Falling-Price Items Declines, as Does Fraction of Items with More-Rapid Price Increases

The fraction of falling-price components, out of the 178 components that potentially go into the trimmed mean, fell slightly, from just over 27 percent of the basket to just over 25 percent.

When components are weighted by the shares in spending, the fraction of the PCE basket experiencing price gains in excess of an annualized 2 percent fell to about 51 percent, compared with about 61 percent in April. Even so, that fraction is off the low values we saw throughout last year, a further confirmation of the pickup in the pace of inflation in 2011. A useful graphical representation of those data can be found on our trimmed mean PCE webpage here:

—Jim Dolmas
June 27, 2011


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