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Behind the Numbers: PCE Inflation Update, October 2012

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.

The Dallas Fed’s trimmed mean PCE inflation rate for October was an annualized 1.0 percent, down from a revised 2.0 percent in September. Together with a string of modest readings over the past several months, October’s trimmed mean rate points to an ongoing gradual deceleration in the pace of underlying consumer price inflation.

For the six months ending in October, the trimmed mean inflation rate averaged an annualized 1.5 percent, down from 1.6 percent for the six months ending in September. Since August 2011, the six-month rate has fallen by 0.7 percentage points.

The 12-month trimmed mean rate for October was 1.7 percent, a slight tick down from 1.8 percent in September. The 12-month trimmed mean rate has slowed by 0.4 percentage points since its most recent peak in January of this year. As we’ve noted before, the current 12-month trimmed mean rate is a good rule-of-thumb predictor for the headline PCE inflation rate over the coming 12 months. We thus expected headline PCE inflation to average about 1.7 percent over the coming year.

The headline rate for October came in at an annualized 1.5 percent, after two months in which it averaged a better than 4 percent annualized rate. Those robust rates were driven primarily by increases in the price of gasoline, and October—as we guessed in last month’s Inflation Update—proved to be a month in which gasoline contributed only negligibly to the headline rate. The “negligibly” here should be understood relative to what’s typical for gasoline—gasoline actually shaved about 0.3 annualized percentage points off October’s headline inflation rate. For any other component of PCE, a contribution of that size would be a notable impact; for gasoline, it’s hardly worth mentioning.

The headline index’s six- and 12-month rates both ticked up in October. The six-month rate increased to an annualized 1.5 percent from 1.3 percent in September, while the 12-month rate increased to 1.7 percent from 1.6 percent in September. Those rates are identical to their trimmed mean counterparts, suggesting that headline inflation is currently close to its underlying trend rate.

Energy Mostly a Nonfactor in October; Gasoline Likely to Pull Headline Inflation Down in November

The PCE price index for gasoline and other motor fuel fell 0.4 percent in October, or about 5 percent at an annualized rate. This drop is slightly bigger than we predicted in last month’s Inflation Update—based on weekly retail price data available at the time, we expected essentially a zero percent change—but not so big as to make much difference for headline PCE inflation.

Most other energy-related components had only minor impacts in October. Among them, electricity services had the biggest impact, contributing just under a tenth of an annualized percentage point to October’s headline inflation rate. Natural gas saw a small decline in price, while fuel oil experienced a small increase.

Looking ahead, when November’s PCE data are released, we should see a large negative impact from gasoline prices. Based on weekly retail price data collected by the Department of Energy, gasoline prices in November are on track for a roughly 8.6 percent decline from October. Only a small part of that decline is seasonal—in recent years a typical November sees a 0.3 percent price decline. Thus, on a seasonally adjusted basis—which is what’s relevant for November PCE—gasoline is on pace for a slightly bigger than 8 percent decline. Given gasoline’s weight in PCE (just under 4 percent), an 8 percent price decline would contribute about –0.3 percentage points to headline inflation (not annualized). Barring any big surprise price movements from other PCE components, that negative contribution from gasoline should be enough to pull the November headline rate into negative territory.

A Pickup in Food Prices

We must confess to having become increasingly skeptical, over the past several months, about forecasts of accelerating food price inflation owing to the effects of drought in the Midwest (we noted one such forecast from economists at the U.S. Department of Agriculture back in the Inflation Update for June). After all, in the six months through September, the PCE price index for food increased a mere 0.5 percent at an annualized rate.

Though only one month, October may nudge us toward a less skeptical view. The price index for food increased at a 3.6 percent annualized rate, driven by large increases in price for meats and poultry, dairy products, cereals and bakery products, and fresh fruits and vegetables.

Most of those categories consist of items at the less-processed end of the food spectrum, and sure enough, our price index for less-processed food items increased at an annualized rate of nearly 12 percent in October.

The increase in overall food prices was restrained by a tame reading for prices of more-processed items. Our index of those prices—which have a weight of about 70 percent in food expenditure—increased just 0.4 percent at an annualized rate. Our more-processed index is up 0.8 for the 12 months ending in October. Over the same period, our index of less-processed items is up 1.4 percent and the price for food as a whole is up 1 percent.

Financial Services, Apparel, Airfare and Rent Among Big Impact Items Outside of Food and Energy

Apart from food and energy, prices of core goods increased at a 0.5 percent annualized rate in October, while prices of core services increased at a 2 percent rate. Over the past six months, core goods prices are down an annualized 0.1 percent, while core services prices are up an annualized 1.6 percent.

Among core goods, the component with the biggest impact on October’s headline inflation rate was women’s and girls’ clothing, which increased 23 percent at an annualized rate and contributed nearly 0.3 annualized percentage points to the headline inflation rate. Two components—men’s and boys’ clothing and jewelry—experienced outsized price declines, though each had an impact of less than –0.1 annualized percentage points on October’s headline rate.

A larger number of non-negligible impacts are to be found among core services, especially within financial services and medical care. The always volatile imputed prices for the services of commercial banks and the services of “other depository institutions and regulated investment companies” experienced outsized declines—annualized drops of 15 percent and 7 percent, respectively—and combined to subtract about 0.3 annualized percentage points from the headline inflation rate. The price index for physician services experienced a more modest decline (annualized 1.1 percent), but still contributed about –0.1 annualized percentage points to the October headline rate.

At the opposite end of the spectrum—components increasing in price—air transportation was the most notable core service, increasing in price at a 43 percent annualized rate and contributing a bit less than 0.2 annualized percentage points to the October headline inflation rate.

Rent growth also had a non-negligible impact in October. Since posting a one-month increase of an annualized 1.5 percent back in June, rent growth has accelerated considerably. October saw the biggest one-month increase in rent (annualized 5.1 percent) since October of 2007.

Given its hefty expenditure weight, owners’ equivalent rent (OER) also had a large impact, though its rate of increase was not out of line with its recent past behavior. OER increased at a 2.6 percent annualized rate in October, after posting rates of 3.1 percent and 2.7 percent in August and September.

On a six-month basis, rent and OER are up an annualized 3.1 percent and 2.1 percent, respectively.

Share of Falling-Price Components Remains Elevated

Last, the share of PCE components experiencing price declines, among the 178 components that potentially enter into the trimmed mean, was 40 percent in October, identical to the share in September. The falling-price share had hit 44 percent in July and 47 percent in August, so September and October’s numbers represent a significant step down (and toward a more normal share near 30 percent).

When components are weighted by their shares of expenditure, the fraction falling in price in October was 39 percent, the highest number we’ve seen for that share in nearly two and half years.

—Jim Dolmas
November 30, 2012


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