Consumer Prices, Retail Sales Bolster Economic Outlook -- 2nd Update

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U.S. consumer prices rose in December, bolstering expectations that long-weak inflation is set to gain strength in the new year.

The consumer-price index, which measures changes in the prices Americans pay for everything from breakfast sausage to doctor visits, increased a seasonally adjusted 0.1% in December from the prior month, the Labor Department said Friday. That small gain matched economists' expectations.

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But prices rose 0.3% in December when excluding the often-volatile categories of food and energy, the largest increase for so-called core prices since January 2017. Economists surveyed by The Wall Street Journal had predicted core prices would rise a more modest 0.2% versus November.

"For now, this report adds more weight to the idea that the run of soft numbers from March through July was 'transitory,'" Pantheon Macroeconomics chief economist Ian Shepherdson said in a note to clients.

Overall prices climbed 2.1% in December compared with a year earlier, easing a bit from November's 2.2% annual gain. Prices excluding food and energy were up 1.8% from the end of 2016, firming slightly from the prior month's annual increase.

A 0.4% rise in shelter costs from the prior month accounted for most of December's inflation uptick. Prices also rose from the prior month for food, medical care and motor vehicles but declined for gasoline and clothing.

In a separate report Friday, the Labor Department said inflation-adjusted average weekly earnings for private-sector workers rose 0.2% in December from the prior month, as wages grew faster than prices and the average workweek was unchanged.

U.S. inflation has been largely subdued for the past half-decade, perplexing Federal Reserve officials who predicted a tightening labor market and continued economic growth would generate stronger wage and price increases. The unemployment rate in December was 4.1%, remaining at its lowest level in 17 years, according to Labor Department data.

Still, many investors and central bankers say inflation is poised to strengthen. The yield on the benchmark 10-year U.S. Treasury note closed above 2.5% earlier this week for the first time since March, and yields moved higher immediately following the release of Friday morning's reports on inflation and consumer spending.

"We continue to believe that this year's surprising softness in inflation primarily reflects transitory developments that are largely unrelated to broader economic conditions," Fed Chairwoman Janet Yellen said in mid-December. "As a result, we still expect inflation will move up and stabilize around 2% over the next couple of years."

One of those one-off factors that has been holding down annual price growth: a drop last spring in prices for cellphone plans. That effect should wash out of the 12-month change in prices later this year.

"Once spring comes around...the big declines in components like wireless telephone services prices will drop out of the annual calculation and the core inflation rate will rebound well above 2%," said Paul Ashworth, chief U.S. economist at Capital Economics, in a note to clients.

Still, some economists and Fed policy makers worry long-sluggish price growth could continue into the new year and might reflect broader problems, such as a deterioration in households' expectations for future inflation.

"I am concerned that persistent factors are holding down inflation, rather than idiosyncratic transitory ones," Federal Reserve Bank of Chicago President Charles Evans said last month after he dissented from the Fed's decision to raise short-term interest rates for a third time in 2017.

Fed officials in December penciled in three additional quarter-percentage-point increases in their benchmark federal-funds rate for 2018, and private-sector forecasters think their next rate increase will likely come in March.

The U.S. central bank also is in the midst of a leadership transition; Ms. Yellen's term ends in early February and President Donald Trump has nominated Jerome Powell, a current Fed governor, as her successor. He is awaiting Senate confirmation.

The Fed's 2% annual inflation target is based on their preferred price measure, the Commerce Department's personal-consumption expenditures price index. The PCE price index was up 1.8% in November from a year earlier, and prices excluding food and energy rose 1.5% on the year.

Write to Ben Leubsdorf at ben.leubsdorf@wsj.com

A modest rise in consumer prices in December and solid growth in retail sales bolstered expectations that inflation is firming after a long run of softness and that U.S. economic growth ended 2017 on a robust note.

Forecasters on Friday raised their expectations for fourth-quarter growth after the Commerce Department reported sales at U.S. retailers, restaurants and websites rose a seasonally adjusted 0.4% in December from the prior month.

Macroeconomic Advisers estimated a 2.7% annual growth rate for gross domestic product in the final three months of 2017, up from its 2.3% estimate as of Thursday.

Forecasters also saw signs of inflation picking up after the Labor Department reported stronger-than-expected growth last month in so-called core prices, which exclude the often-volatile categories of food and energy. The consumer-price index rose just 0.1% from November, but core prices jumped 0.3%, the most in 11 months.

"We've been seeing stronger gains in core inflation, and I think there are good reasons to expect core inflation will be stronger this year as well," said Michael Pearce, senior U.S. economist at Capital Economics.

U.S. inflation has been largely subdued for the past half-decade, perplexing Federal Reserve officials who predicted bigger wage and price increases as the supply of labor and other economic resources became more scarce. The unemployment rate is at its lowest level in 17 years, meaning companies should in theory be competing more aggressively for workers.

Many central bankers say inflation is finally poised to strengthen a bit. They don't want consumer prices to shoot much higher, but they see modest and steady inflation as a sign that the economy isn't running too soft.

Investors, too, appear to be anticipating higher inflation. The yield on the benchmark 10-year U.S. Treasury note closed above 2.5% earlier this week for the first time since March, and it moved higher Friday morning after the inflation and spending data were released. The 10-year breakeven inflation rate, derived from Treasury inflation protected securities, has climbed since late November.

Friday's report on consumer prices offered the latest evidence to support the Fed's view that decelerating price pressures last spring would prove transitory.

On a six-month annualized basis, core consumer prices rose 2.2% in December, up from a 0.9% gain in July and the strongest such increase since declines in prices for wireless-phone plans last March and prescription-drugs in April led to a string of soft inflation readings.

Those declines -- seen at the Fed as one-off events -- have been holding down annual measures of inflation. But they are on track to wash out of inflation readings later this year.

At their latest meeting in December, Fed officials revised up their forecasts for economic growth this year and lowered their forecast for the unemployment rate, citing a short-term boost from the tax cuts enacted after they met.

But they didn't change their projections for gradually raising interest rates, citing in part restrained inflation pressures, and they penciled in three rate increases for this year after raising the benchmark federal-funds rate to a range between 1.25% and 1.5% last year.

An upturn in inflation could overcome doubts about the need for a slightly more aggressive policy path and prompt officials to pencil in a fourth rate increase this year. They are expected to raise rates again in March.

In a speech Thursday, Federal Reserve Bank of New York President William Dudley said he was more concerned about the economy overheating than he was about falling below the Fed's 2% inflation objective on a sustained basis.

"This seems like an odd issue to focus on when inflation is low, but it strikes me that this is a real risk over the next few years," he said.

To be sure, Friday's Labor Department report didn't show a broad breakout for inflation. A 0.4% rise in shelter costs from the prior month accounted for much of December's uptick. Prices also rose from the prior month for food, medical care and motor vehicles but declined for gasoline and clothing.

The Fed's 2% annual inflation target is based on officials' preferred price measure, the Commerce Department's personal-consumption expenditures price index. The PCE price index was up 1.8% in November from a year earlier, and prices excluding food and energy rose 1.5% on the year.

--Sarah Chaney contributed to this article.

Write to Ben Leubsdorf at ben.leubsdorf@wsj.com and Nick Timiraos at nick.timiraos@wsj.com

(END) Dow Jones Newswires

January 12, 2018 13:27 ET (18:27 GMT)