US core inflation came in hotter than expected in January, rising by 0.4% month-on-month versus the more modest 0.3% gain many had expected. While deflation continued in core goods prices – down by 0.3% MoM – services price inflation rose by a strong 0.6% with an unusually large divergence in the rental property price indices.
Actual tenants’ rents rose by 0.4%, but owners’ equivalent rent (or OER, which estimates the equivalent rent a property owner would pay) advanced by 0.6% (see exhibit 1), for the biggest gap between the two measures since the mid-1990s. Because OER and rent are such large components of the overall core consumer price index, accounting for over 40% of it, even such small differences matter for core CPI as a whole.
Had OER risen by the same amount as rent in January (which is the normal situation), overall core inflation would have been almost 7bp lower at 0.32% MoM instead of 0.39%. The difference between the two accounts for much of the higher-than-expected gain in core CPI.
The hotter than expected CPI data sent a flutter through markets counting on the US Federal Reserve to start a series of interest rate cuts this spring. We believe the Fed will take its time and not lower rates until it is comfortable that inflation is under control and on track for its 2% target. The Fed has pencilled in three rate cuts for this year, but not committed to a timeline.
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