Inflation Tame in June, Complicating Fed's Rate Decision -- Update

By Sarah Chaney Features Dow Jones Newswires

Consumer prices were flat in June from the prior month and annual inflation remained well below the Federal Reserve's 2% target, a potential yellow flag for the central bank as it considers interest-rate increases later in the year.

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Inflation is turning into a conundrum for the Fed. Officials have been expecting a pickup as the economy improves, but it isn't appearing.

The Fed's preferred measure of inflation, the price index for personal-consumption expenditures, was unchanged in June from the prior month, the second straight flat reading. It was up 1.4% in June from a year earlier and has dropped for four consecutive months on an annual basis, from 2.2% in February.

Revisions to data showed inflation earlier this year were slightly higher than previously reported.

Consumer spending didn't offer much spark either, rising a tepid 0.1% for the month. Adjusted for inflation, consumer spending was unchanged in June. Personal income was flat, the Commerce Department reported Tuesday, held back in part by a drop in the income households earn on dividends from investments.

Soft energy prices are part of the low-inflation story, but not the whole story. Excluding the often-volatile categories of food and energy, so-called core prices were up 0.1% in June for the second straight month. Core prices have stabilized at 1.5% from a year earlier, which is down from 1.9% reached in February and notches below the Fed's 1.7% end-of-year projection.

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"Core inflation hasn't been quite as weak as previously believed, although the continued shortfall relative to the Fed's 2% target will leave officials with little appetite for a rate hike at the mid-September FOMC meeting," said Andrew Hunter of Capital Economics in a note to clients.

The price index hit and slightly exceeded the Fed's target level in early 2017 for the first time in nearly five years, but has since settled lower. One reason was a drop-off earlier this year in the price of cellphone services, something many Fed officials see as a transitory event.

Excluding wireless telephone prices, core prices rose 1.6% in June from a year earlier, still below the Fed's target.

The Fed sees low inflation as a sign of broader economic weakness, which is why it seeks to keep it steady at around 2%. The persistent softness in inflation readings has some economists wondering if broad forces are at play holding down inflation as prices for items ranging from apparel to shelter have softened in recent months.

"One of the things that's really holding back inflation right now is just the weak wage growth," said Scott Anderson, Bank of the West chief economist. "Without that catalyst of rising real wages, it's going to be hard for inflation to move a lot higher."

In theory, wages should pick up as slack in the job market diminishes and employers have to compete more aggressively for scarce workers. Economists estimate the July unemployment rate ticked down to 4.3% from 4.4% a month earlier and the economy added jobs at a steady pace.

Despite recent soft inflation readings, Fed Chairwoman Janet Yellen said at her congressional testimony in July that it was "premature to conclude that the underlying inflation trend is falling well short of" the Fed's target.

"We have quite a tight labor market and it continues to strengthen, and experience suggests that ultimately, although with a lag, we're not seeing very substantial upward pressure on wages," Ms. Yellen said. "But we may begin to see pressures on wages and prices as slack in the economy diminishes."

Peter Hooper, chief economist for Deutsche Bank Securities, sees an eventual upturn in prices. "As some of the big surprises begin to drop out, the February (and) March declines, particularly in cellphone services, we then expect to start to see things move up," Mr. Hooper said.

Some Fed officials have expressed concern in recent weeks about pushing ahead with interest-rate increases in light of the softening inflation data. Federal Reserve Bank of Philadelphia President Patrick Harker said last month the recent slowing path of inflation gave him pause over whether the central bank should raise its benchmark interest rate for a third time this year.

Overall the economy appears to be advancing at a steady but unspectacular pace.

Consumer spending propelled economic growth in the second quarter, the Commerce Department reported last week. Gross domestic product, a broad measure of economic output, rose at a seasonally and inflation adjusted annual rate of 2.6%, aided by a 2.8% growth rate for consumer spending. That was up from the first quarter's 1.9% growth pace for household outlays.

Write to Sarah Chaney at sarah.chaney@wsj.com

(END) Dow Jones Newswires

August 01, 2017 18:34 ET (22:34 GMT)