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Behind the Numbers: PCE Inflation Update, October 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.

For the second month in a row, our various PCE inflation gauges show a slower pace of consumer price inflation. The headline PCE price index fell at an annualized rate of 0.6 percent in October, dragged down by—of course—the price of gasoline. This follows a moderate 2.1 percent headline reading in September. The headline index’s six-month inflation rate has fallen quite dramatically over the past several months—from a high of 3.9 percent, annualized, in May, to a rate of 1.6 percent in this most recent release.

Core PCE and the trimmed mean also recorded rates for October that were softer than we’d seen this year, prior to September. As usual, though, the steadier trimmed mean displayed a less dramatic downshift. The October core rate came in at an annualized 0.8 percent, on the heels of a negligible 0.1 percent rate in September. The six-month core rate ticked down to 1.7 percent, from 2.0 percent a month earlier.

The trimmed mean, meanwhile, posted a 1.3 percent annualized rate in October—its lowest monthly reading since a 1 percent annualized rate last December. This follows a 1.6 percent rate in September. The six-month trimmed mean rate inched down to an annualized 1.9 percent from 2.0 percent in September.

The 12-month core and trimmed mean rates remain nearly identical, at 1.7 percent and 1.8 percent, respectively, well below the 12-month headline rate of 2.7 percent. If the behavior of the headline index holds true to historical patterns, we can expect it to drift down toward the trimmed mean’s 1.8 percent rate over the next 12 months.

Another dimension that looks similar in September and October data—and dissimilar to prior months—is the number of falling-price items in the PCE basket. In last month’s Inflation Update, we noted a jump in the fraction of components registering price declines, to over 40 percent in September from a more normal range of 30 percent. That elevation continued in October, with 46 percent of the components in the basket falling in price, the biggest such share we’ve seen since October 2010.

We’re naturally conservative when it comes to interpreting shifts in volatile data based on a limited number of observations. Still, taking all these data together—two months worth of softer inflation numbers, back-to-back months with large fractions of falling-price components, and the downward creep in the six-month core and trimmed mean rates—we’re inclined to reassess our view of the underlying trend in PCE inflation. We’re not quite prepared to abandon our view that the trend in PCE inflation is “around 2 percent”—we still think the six-month trimmed mean rate, now at 1.9 percent, is a good indicator of the trend—but the risks associated with that view look to be mainly on the downside.

Gasoline Price Decline Weighs on Headline Rate

After increasing 3 percent in September (not annualized), the PCE price index for gasoline fell 2.9 percent in October, a bit less than the 3.2 percent decline we forecast in last month’s Inflation Update. The decline in the price of gasoline subtracted about 0.1 percentage points from October’s headline number (at a monthly rate), or about 1.3 annualized percentage points.

When PCE data for November are released next month, we should see another negative contribution from gasoline, though one slightly smaller in magnitude. Based on weekly retail price data collected by the Department of Energy, the price of gasoline in November is on pace to be down 0.9 percent compared with October. That’s based on three weeks of data and is not seasonally adjusted. November, it turns out, is a month that normally features a large positive seasonal pop in gasoline prices—typically a 1.3 percent increase. The November weekly data are thus on pace for a seasonally adjusted decline of 2.2 percent, which, if it holds up, would subtract about 1 annualized percentage point from November’s headline PCE rate.

Barring an unusually large jump in the core rate or the rate increase in food prices, November will see a third straight month of milder headline PCE inflation.

Despite an October Dip, Trend Rate of Food Price Inflation Remains Near 5 Percent

We’re happy whenever food price inflation slows, regardless of the underlying cause, but in trying to discern the trend in food price inflation, we know that all decelerations are not created equal.

October was a good month to buy fresh produce, which fell in price at a roughly 30 percent annualized rate. Fresh milk—down 12 percent at an annualized rate—was also a better bargain in October than in September. More objectively—albeit more abstractly—our price index for less-processed food items fell at a 5.7 percent annualized rate in October, and that helped hold down the overall rate of food price inflation to a modest 1.8 percent.

Unfortunately, “less processed” corresponds to “less informative,” at least as far as discerning the trend in food price inflation goes. Declines in prices for those items are nice (for all of us as consumers), but typically tell us little about where the rate of food price inflation is likely to be in coming months.

For that question, the prices of more-processed food items are more informative, and here the picture is less sanguine. Our price index for more-processed items was up 4.9 percent at an annualized rate in October, down a bit compared with September’s 5.6 percent, but still quite robust. The six-month rate of increase in our more-processed index ticked down from an annualized 5.4 percent in September to 5.1 percent in October.

The underlying trend may be turning, but for now it remains around a 5 percent pace.

Service Sector Prices Dominate Big-Impact Items in October Core

From April through August, core goods prices increased at an average annualized rate of about 2.8 percent, and that elevated rate—it compares with a 10-year average rate of about –0.4 percent—goes some ways toward explaining the higher rates of core inflation we saw over that span (annualized 2.4 percent on average). September and October have seen some return to normalcy for core goods prices. Our index of core goods prices rose at a mild annualized rate of 0.4 percent, following a 3.1 percent rate of decline in September (an average –1.4 percent rate). October’s tame reading comes in spite of a rebound in volatile women’s apparel prices (+7.3 percent annualized) and a large jump in jewelry prices (+48 percent annualized). Jewelry alone contributed about a quarter of an annualized percentage point to the overall core rate for October.

Most of the outsized impacts on the core in October, though, came from core services, especially some components of health care. Hospital services of all types fell in price at an annualized rate of over 8 percent in October, and nursing home services fell at more than a 10 percent annualized rate. Taken together, those components shaved a little more than a full annualized percentage point off the October core rate. The price index for hotels and motels and the price index for pension fund services also posted large declines, between them shaving about another 0.4 percentage points off the October core rate.

There were, of course, large impacts at the other end of the spectrum too, notably from the price index for financial service charges, fees and commissions, and the price index for the final consumption expenditures of nonprofit institutions serving households, which combined to add about 0.8 annualized percentage points to the October core rate.

Rent and owners’ equivalent rent (OER) also posted healthy gains. OER increased at an annualized rate of 2.5 percent, up from a 1.4 percent rate in September and more consistent with OER’s performance over June, July and August, during which it averaged a 2.5 percent rate of increase. Rent increased sharply at a 4.8 percent annualized rate, its fastest one-month pace since June 2008. While those gains are not extremely large, given these two items’ hefty weight in core PCE, they still combined to contribute about 0.4 annualized percentage points to the October core rate.

Over the past six months, rent is up at a 3 percent annualized rate, while OER is up at a 2.1 percent rate.

—Jim Dolmas
November 23, 2011


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