May sees largest increase in core inflation since July 2008

by Paul Dalbec and Logan Kelly

The seasonally adjusted annually rate of inflation for all consumer goods and services, as measured by the Consumer Price Index, increased by 0.3 percentage points in May ’11 to 3.4%.  This increase in the inflation can is attributed to increases in all items besides energy.

Large decreases in the prices of energy can be seen as the total energy prices decreased by one percentage point for May.  Gasoline prices especially contributed to this decrease, they decreased by 2.0 percentage points in May. The decrease in gasoline prices comes as a surprise after overall consumer prices for gasoline have risen by 23.7 percentage points in the six months prior to May.  Other energy prices that decreased were the price of energy commodities by 1.9 percentage points, fuel oil by 0.8 percentage points, and utility gas service by 0.3 percentage points, all for the month of May  The only energy prices that increased in May were electricity by 0.8 percentage points and energy services by 0.6 percentage points.

Core inflation, measured as the overall consumer price index minus food and energy, is another important price index, because it is what the Federal Reserve looks at when deciding monetary policy.  Core inflation tends to be a better judge of what economist call persistent inflation.  The Federal Reserve’s interest in persistent inflation is that monetary policy can be used to affect it, as opposed to the more volatile energy and food prices.  Energy and food prices are more volatile and less affected by monetary policy, because they may greatly vary due to weather, overseas wars, etc.  

Core inflation increase by 0.3 percentage points in May to 1.5 percent, which is the largest increase since July 2008.  The Increase in core inflation can be seen across nearly all categories.  In particular, the cost of medical care, shelter and new vehicles all increased. The only decreases were in airline fares, tobacco, and personal care goods. 

Core inflation for the overall year is still lower than the Federal Reserves unofficial target of 2 percent, so the increase maybe a sign continuing economic recovery. On the other hand, both core and headline inflation has been increasing steadily since December. The upward trend in inflation suggests that the Federal Reserve may soon need to begin to tighten monetary policy. Inflation, however, is not yet a serious concern, so it is doubtful the Federal Reserve will react to the May numbers.