Inflation Under Control

The Consumer Price Index, or CPI rose 0.2% in September, down from a 0.4% increase in August and down 1.3% from a year ago. If food and energy prices are stripped out to get to core inflation, prices also rose 0.2%, up from 0.1% in August. Core inflation is up 1.5% from a year ago. On a year-over-year basis, those numbers are likely to flip in the coming months.

Food prices actually declined slightly for the month, with a 0.1% decline in September reversing a 0.1% increase in August, and unchanged from a year ago. In particular, the price for food at home fell 0.3% in September after being unchanged in August. On a year-over-year basis, prices at the grocery stores are down 2.5%. This is not good news for firms like Kroger's (KR - Analyst Report) and Supervalu (SVU - Snapshot Report).

It is energy that is the big difference between core and total inflation. Overall energy prices rose by 0.6% in September following a 4.6% surge in August. However, a year ago energy prices were collapsing, and on a year-over-year basis they are down 21.6%. The low price for oil was in December, and as we reach the aniversary of that low, year-over-year headline inflation will start looking much higher.

However, both rent and owners-equivalent rent, which is how the government tracks housing inflation for homeowners (esentially assuming you rent your house to yourself), both fell by 0.1% in September. Those were the first declines measured for those catagories since 1992.  This is extremely important, since together rent and owners-equivalent rent makeup almost 30% of the total CPI and almost 40% of the Core CPI. With the supply of rental housing far outstripping demand and vacancies surging, both types of rent could be falling for a long time to come.

The decline in rents were partially offset by a surge in hotel costs (also considered part of housing), which looked very strange to me given the other data from the hotel industry -- showing that both occupancy and the average daily rate are falling. Given the huge weight of housing on the index, it means that inflation -- particularly core inflation -- is going to stay under control for the foreseeable future.

Part of the increase in core inflation was a side effect of the Cash for Clunkers program, which cleared up the excess inventories of new cars and reduced the supply of used cars.  The price of new cars rose by 0.4% in September, after falling 1.6% in August.  Used car prices rose by 1.6% following a 1.9% rise in August.  This would correspond to news from automakers like Ford (F - Analyst Report) that the levels of rebates and other incentives are down sharply from earlier in the year.  

As always, the other problem area was health care. The cost of medical goods such as drugs and replacement parts (a.k.a. medical devices) rose by 0.6% on the month, following a 0.5% increase in August and are up 4.1% year over year -- once again far outpacing the overall rise in both core and headline inflation. If inflation in health care is not brought under control soon, it will bankrupt the country.

This data suggests that the focus of the Federal Reserve right now should be on stimulating the economy and not to worry about inflation too much. This means that they should keep the Fed Funds rate near zero and keep the quantitative easing programs in place.