US inflation drops, but core extends uptrend

In February, the impressive uptrend in US inflation came to an end. Both PCE and CPI inflation dropped, mainly due to lower energy prices. In addition, positive base effects stemming from the 2014‐2015 drop in oil prices are now fully worked out. In the coming months, negative base effects will weigh on headline inflation, but this might be (partially) offset by the recent rebound in the oil price.

Although headline inflation slowed, both the core PCE and CPI extended its upward trend. The core CPI jumped further above 2% (to 2.3% Y/Y) and also the core PCE (currently 1.7% Y/Y) is nearing the Fed’s target. A closer look at the details and other measures of inflation and inflation expectations confirms that the dip was only energy related and core inflation is further extending its upward trend (see table below). Furthermore, most measures of core inflation and indicators tracking the underlying trend are above or close to the 2%‐target.

Contrary to the “hard” inflation data, most survey and market based measures of inflation and inflation expectations remain exceptionally low. Compared with last month however, most “soft” measures of inflation and inflation expectations improved (see table below), which is a first encouraging sign.

Negative base effects to weigh on inflation

US inflation might ease somewhat further in the coming months, or at least the uptrend will slow due to negative base effects, which will be (partly) tempered by the recent rebound in oil (and other commodities). Later in the year however, US headline inflation will extend its upward trend, boosted by positive base effects and continued strength in domestic demand.

In the meantime, US core inflation extends its uptrend with the core CPI rising further above 2% and the core PCE nearing the Fed’s target. We expect core inflation to extend its gradual uptrend, supported by a further labour market recovery and increasing wages together with continued growth in consumer spending. We believe therefore that the risk of US inflation undershooting the Fed target is limited. Yellen however indicated that rates won’t be increased in the near term due to global and financial risks.

US inflation drops, but core extends uptrend