Markets are nervous regarding US inflation. The publication of the January US data on inflation and real earnings is a good example of the widespread nervousness in financial markets. All-urban-headline-inflation exceeded expectations by 20bp (2.1% year on year, 1.9% in Bloomberg’s expectation; 0.5% on a monthly basis, 0.3% in Reuters’ poll), but real earnings for the total economy decreased on the previous month and confirmed the year on year growth rate at below 1% as in the last sixteen months.
January core inflation came at 1.8%, as in December, but with a higher contribution to headline inflation of 7 basis points (Chart 1). These releases pushed the dollar down against major currencies and the 10-year Treasury yield up to 2.9%. The stock market lost ground anticipating a more aggressive monetary policy, but the day of the inflation release closed with gains, helped by the publication of the drop in retail sales in January. The economy has to grow, but not “too much”!
On the whole, inflation remains low in a historical perspective, given that the US economy is in its ninth year of expansion and the unemployment rate is at 4.1%, suggesting a situation of full employment.However, market nervousness will not disappear in the coming months, as several factors are likely to push up inflation.
Upward factors are likely to materialize in 2018. A weak dollar could have an effect on domestic prices via import prices. In January, the nominal trade-weighted dollar exchange rate declined around 8.5% year on year. Higher oil and commodity prices could feed into headline inflation as well. Since the beginning of the year the WTI oil price on average has been 20% higher than in the corresponding period of 2017 and the energy components represent around 7% of the total CPI basket of goods and services.
Transitory factors that contributed to keeping inflation low in 2017 are going to fade away, the most significant being in communications and medical care sectors. Communication prices reflected the move to the flat rate for unlimited download data that Verizon offered to its wireless customers at the beginning of 2017 and that is behind the negative contribution (-0.22pp, January) of communication to core inflation growth (Chart 2). Similarly, mandate cuts to Medicare payment in 2017 contributed to keeping the growth of service prices in the health sector low, reducing the contribution of this item to core inflation.
Little evidence of higher labour costs yet. On the other hand, looking at wages, there is not yet any evidence of near term demand pressures and/or transfer of higher labour costs to prices, as unit labour costs are still trending downwards. With regard to hourly earnings in the macro sectors, only financial services show a clear upward trend but this sector represents only 7.4% of total worked hours. Larger sectors, such as educational and health services (17.8% of total worked hours) and professional and business services (17.3%), show growth rates of hourly earnings around 2.5% without a clear upward trend. In contrast, wholesale trade (11.5% share of total worked hours) and durable goods (4.4%) show a clear downward trend of hourly earnings growth.