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Behind the Numbers: PCE Inflation Update, March 2014

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.

The headline PCE price index rose at a 2.3 percent annualized rate in March, compared with a 0.8 percent rate in February. Energy prices were mostly a nonfactor in March, as declines in the prices of gasoline and fuel oil were effectively offset by increases in the prices of natural gas and electricity. Food prices, up 5.6 percent at an annualized rate, made a noticeable positive contribution to the headline inflation rate, accounting for 0.3 percentage points of the annualized 2.3 percent headline rate.

The main factor explaining March’s more robust headline reading, though, was a faster rate of core services inflation, which clocked in at a 2.9 percent annualized rate in March, up from a 1.5 percent rate in February. Shelter costs—in particular rent and owners’ equivalent rent (OER)—were key drivers of the acceleration.

The Dallas Fed’s Trimmed Mean PCE inflation rate for March was an annualized 1.9 percent, compared with a 1.1 percent rate in February, and above the trimmed mean’s recent average pace of 1.3–1.4 percent. The six-month trimmed mean rate held steady at an annualized 1.4 percent for a fourth consecutive month, while the 12-month trimmed mean rate posted a third consecutive reading of 1.3 percent.

The 12-month headline PCE inflation rate ticked up to 1.1 percent from 0.9 percent in February. As usual, our rule-of-thumb forecast for headline PCE inflation over the coming 12 months is the current 12-month trimmed mean rate (1.3 percent). We thus expect a further small acceleration in the 12-month headline PCE inflation rate over the coming months.

Energy Prices Flat in March

The PCE price index for energy goods and services was essentially unchanged in March, reflecting offsetting movements in the prices of gasoline, fuel oil, natural gas and electricity. Gasoline prices fell 1.7 percent on a month-to-month basis, while fuel oil prices fell 2.9 percent. The declines were effectively canceled out by increases in the prices of natural gas services (up 7.5 percent for the month) and electricity services (up 1.1 percent).

The increase in price for natural gas was the largest monthly gain we’ve seen since October 2005 and comes on the heels of robust increases in both January and February (each 3.6 percent). The three-month increase—just over 15 percent—is the largest since July 2008.

The 1.7 percent decline in the price of gasoline in March was slightly smaller than the 2.2 percent drop we predicted in the last Inflation Update and identical to the decline we saw in February’s PCE data. Gasoline prices—which are seasonally adjusted in the PCE— are down 5 percent from March 2013, with most of that decline (4.2 percent) coming in the past six months.

Based on more current weekly Department of Energy (DOE) data, we should expect about half of that six-month decline to be reversed when PCE data for April are released. The DOE data show gasoline prices in April on track for a 3.9 percent increase, before seasonal adjustment. Taking account of the normal seasonal variation in gasoline prices—April typically sees a 1.2 percent increase—we would expect to see a seasonally adjusted 2.7 percent increase in the next PCE release. Given gasoline’s weight in expenditure, a 2.7 percent price increase corresponds to a contribution to April’s headline inflation of about 1 annualized percentage point (in contrast, gasoline subtracted roughly 0.8 annualized percentage points in March).

Food Prices Up Again; More-Processed Items Show Gains

Food prices posted a second consecutive robust gain in March, rising at a 5.6 percent annualized rate after rising at a 3.3 percent rate in February. Prices for less-processed food items increased sharply in March, just as they did in February, with both months seeing gains of 14 percent at an annualized rate. Prices for fresh fruit, fresh dairy products and beef all recorded substantial increases.

In contrast to February, though, the latest data also show a noticeable increase in prices of more-processed items, which were up at a 2.4 percent annualized rate. Among more-processed items, cereals (up at a 16.7 percent annualized rate) and processed dairy products (up at a 15 percent rate) posted the largest price increases.

We tend to view the behavior of prices for more-processed items as more informative about the underlying trend in food price inflation, so the pickup in this month’s release is notable. Still, we never put too much weight on one observation—December saw a similar increase in prices of more-processed items, and that reading was immediately followed by two straight declines. These data will bear watching, though, over the coming months.

Despite the past two months’ price increases, prices for food as a whole are up at an annualized rate of just 1.5 percent over the past six months. Over the same span, prices for less-processed items are up an annualized 4.6 percent and prices for more-processed items are up just an annualized 0.3 percent.

‘Big Three’ Core Services All Post Rates Above 3 Percent in March

Outside of food and energy, prices for core goods were essentially unchanged in March after falling at a 0.4 percent annualized rate in February, while prices of core services rose at a 2.9 percent annualized rate after increasing at a 1.5 percent annualized rate the month before. The increase in core services prices was the largest one-month gain we’ve seen since mid-2012.

Among core goods, prescription drug prices—down at a 2.6 percent annualized rate in March—made the biggest impact on March’s headline inflation rate, subtracting a bit more than 0.1 annualized percentage points from the headline rate. The decline in prescription drug prices comes on the heels of two consecutive outsized price increases—annualized 7.4 percent in January and 11.1 percent in February. On a 12-month basis, prescription drug prices are up 2.1 percent, a modest rate compared with the series’ longer-term average behavior (an annualized 3 percent rate of increase over the past 10 years).

Among core services, the price indexes for hotels and motels (up an annualized 24.5 percent) and physicians’ services (down an annualized 0.5 percent) had the most outsized—though largely offsetting—impacts on headline inflation in March. The two service components added and subtracted just over 0.1 annualized percentage points from March’s headline inflation rate.

The price decline for physicians’ services continues a pattern of decelerating medical services inflation that has been ongoing for the past several years. The PCE index for health care services is up just 0.8 percent on a 12-month basis, a multi-decade low.

As noted in the introduction, though, the key drivers behind the pickup in core services inflation in March were two components of shelter, rent and owners’ equivalent rent (OER). Rent increased at a 3.8 percent annualized rate in March, its fastest monthly pace since last August, and well above its 12-month average rate of 2.9 percent. At the same time, OER posted a 3.2 percent annualized rate of increase in March, after recording annualized rates of increase of 2.5 percent and 2.1 percent in January and February. For the 12 months through March, OER is up 2.6 percent.

Rent and OER are two of the three items that go into what we call the “Big Three” core services—three components that combine large expenditure weights with very low volatility (hence a high ratio of “signal” to “noise”). The third is the PCE price index for “other purchased meals” (essentially the price of dining out), and this component also posted a better than 3 percent rate of increase in March, rising at a 3.5 percent annualized rate. For this component, though, March looks a lot like February (which saw an annualized 3.6 percent rate of increase), so the price of dining out was not a factor in explaining the faster rate of core services inflation we saw in March compared with February.

Not surprisingly, our “big three index,” consisting of just these three services, increased at a 3.4 percent annualized rate in March. The index’s six- and 12-month rates each ticked up: the six-month rate to an annualized 2.7 percent from 2.5 percent, and the 12-month rate to 2.6 percent from 2.5 percent.

—Jim Dolmas
May 1, 2014

 

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