Kiplinger Inflation Outlook: Tariffs Not Yet Affecting Inflation

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Headline inflation remained moderate in May at 2.4%. Core inflation (prices excluding food and energy) stayed at 2.8% for the third month. Cost increases in non-energy services slowed a bit to 0.2% as both housing and health care price increases moderated.

Also helping out was a 1.0% decline in energy costs, and modest dips in new and used vehicle prices. This last is unlikely to continue, however, because of tariffs on car imports.

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The price of groceries rose modestly, on average, helped by a continued decline in egg prices (down 2.7%). The avian flu had severely reduced flocks at egg-laying chicken farms, but farmers may have turned a corner. Prices are still 41.5% higher than a year ago, however. The cost of dining out continued to rise at a moderate pace.

Tariff effects on prices so far appear to be limited to toys (up 1.3%) in May. However, more effects should filter in gradually, as a number of businesses are able to first dig into existing inventories, or absorb tariff costs for the moment before passing on price increases to their customers.

The 25% duties on imported cars and auto parts will eventually raise both the average prices of new and used vehicles, and the cost of vehicle repair and insurance. Despite the imminent U.S.-China trade pact, the remaining 30% tariff on China and 10% tariff on most other countries will affect prices of clothing, electronics and many other goods.

May's moderate inflation will please the Federal Reserve but is unlikely to give the central bank enough reason to cut interest rates when the Fed meets on June 18. The Fed will want to see the effects of tariffs on inflation over the next several months before acting. Since tariff effects on consumer prices will happen only gradually, the Fed is likely to be on hold for a number of months in order for it to be able to assess the impact.

While the headlines focus on the Consumer Price Index, note that the Fed's goal of 2% inflation is based on a measure called the personal consumption expenditures deflator, not the CPI. The PCE deflator excluding food and energy rose at a 2.5% rate for the 12 months ending in April, compared with the core CPI’s 2.8% March number. But that is still too high for the Federal Reserve's 2% target.

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