Thursday, 16 June 2011

Inflation: U.S. Consumer Price Index to drop in June


The US consumer price index rose significantly to 3.44% in May from a year ago and 0.2% from its April level. The increase was bang on target with my estimate. However, I believe that May’s figure on a year-ago basis approached a plateau in the current cycle.

My analysis indicates that changes in the CPI inflation rate on a year-ago basis and especially CPI ex shelter are explained by changes in the oil price compared to a year ago. It is particularly evident since the end of 2006 where more than 94% of the direction of the CPI ex shelter is explained by the year-on-year absolute change in the price of crude oil.

Sources: I-Net Bridge; Plexus Asset Management.

Shelter’s weight of approximately 32.3% in the CPI and the one-month lag between the change in the oil price and CPI ex shelter inflation enables me to make a reasonably accurate forecast. The change in the oil price is a known factor while the only unknown factor is the CPI shelter CPI. But with a more stable trend the CPI shelter CPI inflation rate that can be expected is fairly reasonably assumed.
Sources: Bureau of Labor; Plexus Asset Management.

The year-on-year change in Light Louisiana Sweet crude in May was $41.53 per barrel. The historical relationship between the change in the Light Louisiana Sweet crude and the CPI ex shelter inflation rate points to a year-on-year CPI ex shelter inflation rate of 4.77% in June given the said lag. That makes up 67.7% of the overall CPI inflation rate (overall CPI minus the 32.3% weight of the shelter CPI) and will therefore be 3.23%. If I assume a year-on-year change of 1% in the shelter CPI, May’s total CPI will add up as follows:
(67.7% of 4.77%) plus (32.3% of 1%) = 3.23% plus 0.32% = 3.55%.

The 3.55% inflation rate means that the consumer price index will drop by 0.1% in June. The first decline since June last year!
But where is CPI inflation heading?

Without taking a stab at where the oil price is heading, I looked at three scenarios where the price per barrel of Louisiana Sweet crude was kept constant at $100, $115 (current) and $130 respectively for the next 12 months. The monthly oil price was then compared to the price a year ago and depicted against the CPI ex shelter inflation rate lagged by one month.
Sources: Bureau of Labor; I-Net; Plexus Asset Management.

By applying the historical regression equation the trend of future CPI ex shelter year-on-year inflation is as follows:
Sources: Bureau of Labor; I-Net; Plexus Asset Management.

Assuming that the year-on-year inflation rate for shelter remains steady at 1.0%, the outlook for the overall CPI inflation rate is as follows:
Sources: Bureau of Labor; I-Net; Plexus Asset Management.

Year-on-year CPI inflation Rate %
@ constant $115/barrel@ constant $130/barrel@ constant $100/barrel
May-113.44 (actual)
Jun-113.553.553.55
Jul-113.324.032.61
Aug-113.153.862.44
Sep-113.444.152.73
Oct-113.013.722.30
Nov-113.023.732.31
Dec-112.853.562.14
Jan-122.513.221.80
Feb-122.112.821.40
Mar-121.552.260.84
Apr-121.352.060.64
Sources: Bureau of Labor; I-Net; Plexus Asset Management.

It is evident in the above that the US CPI inflation rate is likely to peak at 3.55% in June if the oil price maintains its current level or weaken. Even if the oil price spikes to $130 per barrel and maintains that level, the inflation rate will still top out in July this year. There may be a short further spike in September owing to a brief drop in the oil price in August last year.

by Prieur du Plessis

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