After four consecutive months of gains, headline CPI in December increased by 0.3 percent, in line with consensus expectations based on the Bloomberg survey. Once again, higher energy prices were a significant driver behind the gain, rising 1.5 percent. Food prices remained flat for the sixth consecutive month. Excluding food and energy, the core CPI increased by 0.2 percent, also consistent with expectations.
For the year, headline CPI rose 2.1 percent, predominantly driven higher by the extended recovery in energy prices. Just one year ago, the index had increased by a tepid 0.7 percent for calendar year 2015 – driven down as global oil prices collapsed.
Core inflation, which strips out the impact of the more volatile food and energy prices, increased 2.2 percent over the preceding twelve months, a healthy pace considered supportive as a means to “grease the wheels” of the economy. While the headline index moved appreciably higher over the course of the year, core inflation remained remarkably stable in a narrow 2.1 percent and 2.3 percent range in 2016.
Inflation has ticked up as overall economic growth continued after accelerating dramatically in the third quarter to 3.5 percent, buoyed by stronger consumer spending and a recent surge in sentiment. The firming in household spending has been supported by a tightening job market that has started to deliver stronger wage gains that will, in the absent of better productivity, ultimately add to inflationary pressures.
Last Friday’s release of the index of consumer sentiment reaffirmed the market’s early reaction to the prospect of a stronger economy lifted further by President elect Trump’s pro-growth policy agenda. The survey’s measure of longer-run inflation expectations climbed to 2.5 percent while the median inflation expectation for the next year also rose to 2.6 percent – up from 2.2 percent in December — an indication that consumers are also settling in with the prospect of higher prices and with the reality of what the new administration’s agenda may mean for them.
Further momentum in consumer prices could add to the perception of a more hawkish Fed and the potential for more aggressive tightening. While the Fed itself may not be fundamentally more hawkish, increasing inflation fits the market’s narrative of a Trump presidency. A combination of higher actual inflation and rising expectations would prove helpful to the Fed as the central bank attempts to normalize policy rates.