Alex Tovstanovsky, owner of used car dealer Prestige Motor Works, checked on Jan.

Nick Carey | Reuters

Consumer prices rose faster than expected in May, but the rise in inflation appears temporary and should not force the Fed to tighten monetary policy for the time being.

The consumer price index rose 5% yoy in May, its highest level since 2008, when oil prices soared. Excluding food and energy, core CPI rose 3.8% yoy, its highest since 1992. A third of the increase was due to a sharp 7.3% increase in used car and truck prices.

“The rise in inflation is stronger than expected, but it still looks like it is in transition categories,” said John Briggs, global head of desk strategy at NatWest Markets. “[Fed officials] can probably get away with talking about the ephemeral. “

The Federal Reserve meets on June 15th and 16th. There has been some market speculation that if inflation looked very hot, the central bank could postpone the timeframe in which it would begin cutting its bond purchases. Many economists had expected the Fed to speak for the first time about tapering bond purchases at its Jackson Hole economic symposium in late August before actually reducing the size of purchases in late 2021 or next year.

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“There is evidence that it’s temporary because much of the price hike is going to things that are about to normalize … hotels and rental cars and used cars, sporting events, restaurants it was before the pandemic,” said Mark Zandi, chief economist at Moody’s Analytics. “It’s fleeting. This is unique. “

However, he added that it was too early to say that inflation will not be more persistent than the Fed expects. “It is premature to conclude that all of this is temporary and that underlying inflation will eventually land once we get through price normalizations,” Zandi said. He expects inflation to be higher after the spike ends than it was before the pandemic.

The Fed has announced that it would tolerate inflation above its 2% target and would consider an average range for inflation. This means that it has committed itself to waiting for interest rates to rise as soon as the risk of inflation increases.

Financial markets easily absorbed the rise in the CPI and stocks rose at 8:30 a.m. ET after the report. The Dow gained more than 200 points but gave up its best gains late this morning. The 10-year Treasury was slightly higher at 1.49% after initially rising to 1.53%. The returns move against the price. Fears that inflation would cause the Fed to change monetary policy earlier would have driven yields much higher.

The components of higher prices

“The used car component is just amazing,” said Grant Thornton Chief Economist Diane Swonk. “It is surprising how low the shelter share has remained. It comes from where it was braked. Now the question arises whether it attracts. We have to watch that, but I would have expected more from an increase in the hotel room.” . “

Shelter accounts for more than 30% of the CPI. The Shelter Index rose 0.3% in May and 2.2% over the past 12 months. The rent share rose by 0.2% and the index for the equivalent rent of a tenant rose by 0.3%. Out-of-home accommodation rose only 0.4% after rising 7.6% in April.

Another big component, health care, fell 0.1% after rising in the previous four months. Health care prices rose only 0.9% over the past 12 months, the smallest increase since March 1941.

“Healthcare and housing are two very big components of inflation. They are both very persistent and one reason to believe that inflation will settle at higher levels, but not at uncomfortable levels,” said Zandi. “The reason for being so optimistic is because of medical care and housing.” He said expanding the Affordable Care Act helped cut medical costs.

The rise in inflation is stronger than expected, but it still looks like it is in transition categories.

John Briggs

Global Head of Desk Strategy at NatWest Markets

Grant Thornton’s Swonk said she wasn’t expecting much from the Fed next week, and the inflation report won’t change that.

“The long bond’s remarkable resilience gives the Fed an opportunity to consider tapering as financial markets buy it as a temporary surge in inflation,” said Swonk.

Once the Fed starts talking openly about a tightening, it is expected to wait several months before starting to curb $ 120 billion in monthly government bond and mortgage purchases. Once the settlement is completed many months later, the door would be open for Fed officials to hike rates, which is not expected by the markets until 2023.

“I always expected that when we met in Jackson Hole, the talks about the reduction would start more openly. That didn’t change my mind. Some people thought the Fed was getting closer to full employment before starting the cut, ”Swonk said.

She said some data in the CPI report is in line with weaker-than-expected employment data. The economy created 559,000 jobs in May, around 100,000 fewer than expected.

“If you look at the combination of events – used car prices, vehicle insurance costs, all of these things have accelerated and now they are recovering. The prices at the pump are over 50% higher than a year ago, ”said Swonk. “All of this makes it difficult for workers to get low-wage jobs.”