Wednesday, January 11, 2017

Gas prices set to drive inflation over Fed's target

 - by New Deal democrat

In case you hadn't already noticed, that big decline in gas prices you saw at the pump has come to an end.  At the moment gas prices are up about 20% YoY.  Thus gas prices are one of my five graphs to watch in 2017.

Which means, this is a good time to revive a back-of-the-envelope calculation I used to do when gas prices of $4 would act as a choke collar on economic growth.

The calculation goes like this:  core inflation has reliably run at +0.1% or +0.2% a month.  Almost all of the variability in the remaining number is due to gas prices. Based on past experience, take the change in gas prices in any given month, divide it by 10, and add that to the underlying core inflation rate.  That will give you the non-seasonally-adjusted inflation rate for any given month, +/-0.1%.

Here's what that looks like over the last year. Blue is the average change in gas prices in the month divided by 10, red the non-seasonally-adjusted inflation rate, and green the seasonally adjusted inflation rate:

Note that gas prices rose in December 2016, unlike December 2015.  That suggests that December 2016 inflation, after seasonal adjustment, is likely to be about +0.2%. Since December 2015 was -0.3%, that will raise the YoY inflation rate from 1.7% to over 2%.

Since consumer inflation bottomed in February of last year, here's what consumer inflation looks like since then:

From February through November, consumer prices rose +1.9%. An additional +0.2% will make that +2.1% for 10 months -- above the Fed's 2% target.  So unless we have a big miss in the next employment report, I expect the Fed to chase this inflation with a rate hike.