US headline inflation likely to accelerate towards 3 pct by Q1 2017

US recorded a 0.2 percent rise in consumer prices in May, as compared to market projection of a rise of 0.3 percent. Core inflation, stripping energy and food, also rose 0.2 percent on the month.  On a year-on-year basis, the pace of headline inflation slipped somewhat to 1 percent, whereas core inflation accelerated to 2.2 percent.

Energy prices, which rose 1.2 percent on sequential basis, drove the headline inflation once again in May. As oil prices are expected to continue increasing modestly in the rest of 2016, headline inflation is expected to accelerate towards 3 percent year-on-year by the first quarter of 2017, noted TD Economics in a research report. Meanwhile, core inflation is expected to remain around its current pace for the rest of 2016. In the second half of 2016, the disinflationary push from a higher USD is likely to diminish.

In May, gasoline prices grew 2.3 percent on a sequential basis; however, it was slightly countered by declining prices in electricity, which dropped 0.2 percent. Meanwhile, services, which rose 0.3 percent month-on-month, drove the rise in core prices. Currently, core services inflation is at 3.2 percent year-on-year, which is a post–recession high. Meanwhile, core goods prices dropped for the third straight month due to lower prices for items such as prescription drugs, vehicles and computers.

With the continuing strong job growth, the labor market is approaching full employment. This is seen in wage growth that is witnessing rising acceleration. The Atlanta Fed wage tracker was at 3.5 percent year-on-year in May.

For the US economy or the Fed, inflation is not an immediate worry; however, financial markets are expected to be just slightly satisfied about the inflation currently. The core personal consumption expenditure deflator, which is the US Fed’s preferred inflation measure, is expected to move higher through the year, likely permitting at least one interest rate hike by the central bank in the second half of 2016, according to TD Economics.