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Behind the Numbers: PCE Inflation Update, July 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.

After three months of increases in excess of an annualized 2.5 percent, the headline, or all-items, PCE price index rose a modest annualized 1 percent in July. Sharp declines in price for gasoline, women’s and girls’ clothing, and hospital services were significant drags on July’s headline rate.

Prices for energy goods and services as a whole fell at a 4.3 percent annualized rate, while food prices, which had been essentially flat in June, increased at a 3.2 percent annualized rate in July. In terms of their contributions to headline inflation, the movements in energy and food prices were roughly offsetting. Prices for core goods fell at a 0.3 percent annualized rate, after rising at an unusually rapid 2.7 percent rate in June. Prices for core services rose at a 1.7 percent annualized rate, up from a 1.4 percent rate a month earlier.

The six-month headline inflation rate was an annualized 2 percent in July, unchanged from June. The 12-month headline rate was 1.6 percent, also unchanged from the previous month.

Like the headline rate, the Dallas Fed’s trimmed mean PCE inflation rate also showed some moderation in July compared with the prior three months. July’s trimmed mean rate was an annualized 1.4 percent; this follows readings of annualized 2.6 percent, 2.4 percent and 1.9 percent in April, May and June.

The six-and 12-month trimmed mean rates moved in opposite directions in July, with the six-month rate ticking up 0.1 percentage points to an annualized 1.9 percent and the 12-month rate ticking down 0.1 percentage points to 1.6 percent. Note that the 12-month trimmed mean rate is identical to its headline counterpart. Since our rule-of-thumb forecast for headline PCE inflation over the next 12 months is just the current 12-month trimmed mean rate, we expect headline PCE inflation to continue to average 1.6 percent over the coming year.

Energy Prices Down in July; Bigger Declines in the Pipeline

Gasoline prices fell in July by less than we predicted in the last Inflation Update (based on partial data for the month), declining by a seasonally adjusted 0.3 percent (or 4 percent at an annualized rate). The decline was still sufficient to shave roughly 0.2 annualized percentage points off July’s headline inflation rate.
Prices for the other major energy goods and services experienced similar declines: Fuel oil was down 0.7 percent, electricity, 0.3 percent, and natural gas, 0.4 percent. On a 12-month basis prices for natural gas and electricity are still up noticeably (6.9 percent and 4 percent, respectively), in spite of recent declines. Prices for gasoline and fuel oil are up more modestly over the same period (1 percent and 2.2 percent, respectively).

Based on the data we have so far for August, we should expect energy prices to continue to drag on headline inflation when PCE data for that month become available. Weekly retail price data from the Department of Energy show gasoline prices on track for a 3.3 percent decline in August. Those data are not seasonally adjusted, but, as it turns out, there is only a negligible seasonal component in the typical July-to-August change in gasoline prices. Thus, a 3.3 percent decline is—based on the data we have so far—a good prediction for the seasonally adjusted price change that will figure into August’s PCE release. Given gasoline’s share of PCE (about 3.1 percent), a price decline of that size would shave about 1.2 annualized percentage points off the headline PCE inflation rate.

Food Prices Rebound

After posting an essentially zero rate of increase in June, food prices rose by an annualized 3.2 percent in July. And in contrast to the pattern established over the past several months, the culprit was a robust gain in prices of more-processed food items, which were up at an annualized 3.7 percent rate. Posting sharp increases were the PCE price indexes for bakery products, “coffee, tea, and other beverage materials,” and “food products not elsewhere classified, ” the latter of which includes, among other things, snack foods, soups and condiments.

One month does not make a trend, and our index of prices for more-processed food items is still up just 0.6 percent over the past 12 months. Still, these data will bear watching in the months ahead, as we tend to think of the behavior of prices for more-processed food items as reflecting the choices of producers who are making more complex, forward-looking pricing decisions.

Our price index for less-processed food items, meanwhile, increased 1.9 percent at an annualized rate in July—not negligible, but well below the average annualized 10 percent rate we’ve seen over the past six months or the 5.5 percent rate posted over the past 12 months.

Prices for food as a whole are up an annualized 3.9 percent and 2 percent, respectively, over the past six and 12 months.

Financial Services, Hospitals Weigh on Core Services

As noted above, core goods prices declined at a 0.3 percent annualized rate in July, following a 2.7 percent rate of increase in June. As regular readers of the Inflation Update will know, of those two numbers it is July’s slight decline that is more in keeping with the historical norm for core goods prices (over the past 20 years, core goods prices have averaged about a 0.4 percent annualized rate of decline).

Core services prices rose at a moderate 1.7 percent annualized rate in July. This is up from June’s 1.4 percent, but below the average rates we’ve seen over either the past six months (2.2 percent) or 12 months (2.1 percent). (And those six- and 12-month rates are themselves below core services’ longer-run average, which is a 2.5 percent rate of increase over the past 20 years.)

The surprising thing about core services’ moderate rate of increase in July is that it comes in the face of very strong increases in the prices of what we refer to as our “big three” core services—rent, owners’ equivalent rent (OER), and dining out. Adding up to roughly 30 percent of core services expenditures, the big three—taken as a whole—increased in price at a 3.5 percent annualized rate in July. Rent (up at a 4 percent annualized rate), OER (3.1 percent) and dining out (4.3 percent) all posted notable increases.

A little back-of-the-envelope math indicates that the rest of core services—that is, core services apart from the big three—must have increased at a roughly 0.9 percent annualized rate in July. The prime culprits in this weak reading were financial services (taken as a whole, down an annualized 0.2 percent) and hospital services (down 1.9 percent). Financial services prices are historically quite volatile, while prices for hospital services have—at least over the past couple years—exhibited greater-than-normal volatility, so there is likely very little signal value in their outsized price declines. Outsized declines in these components—especially financial services—are apt to be followed shortly by outsized price increases.

The big three, in contrast, exhibit very low volatility—movements in their prices tend to persist over time. And, if we gauge how informative a PCE component is about underlying inflation by how often it gets included in the trimmed mean, then the big three are three of the most informative components in the PCE basket.

Our “big three index,” which aggregates the price indexes for rent, OER and dining out, is up 2.8 percent on a 12-month basis. This is 0.5 percentage points higher than the index’s 12-month rate one year ago—i.e., for the 12 months through July 2013.

—Jim Dolmas
August 29, 2014


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