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Top inflation gauge followed by Fed chief Powell looks rosier in thorny CPI report

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Looking for a rose in a thorny January report on U.S. consumer prices? Investors can find one in so-called “supercore inflation”. It barely rose last month.

See: CPI shows inflation still sticky and slowing grudgingly

Supercore inflation refers to the rate of inflation in the services sector after stripping out energy and housing costs. It’s arguably the most important inflation gauge to Federal Reserve Chairman Jerome Powell, whose decisions could make or break the U.S. economy.

Supercore inflation rose a scant 0.2% in January, the third such low reading in the last four months, based on calculations by Haver Analytics. (The number itself does not exist in the CPI report.)

High labor costs are a big worry in the Federal Reserve’s fight against inflation.

Mario Tama/Getty Images

What’s more, the yearly rate of increase in supercore inflation slowed again to 6.1% last month from a 22-year high of 6.7% in September.

Why is this number so important? The Fed’s biggest worry is that a recent surge in worker pay due to an extremely tight labor market will exacerbate inflation or make it harder to slow down.

If wages kept rising rapidly, the thinking goes, inflation would get stuck at a 4% or 5% rate in the long run and cause severe damage to the economy.

The Fed is trying to get inflation back down to its 2% target. Inflation rose an average of less than 2% a year in the decade before the pandemic.

Supercore inflation is seen as the best way to determine the effect of wages on prices. That’s because most U.S. businesses provide services — think retail, banking and recreation — and labor is their single largest cost.

Powell made it clear how much he values this measure of inflation in a speech a few months ago.

“This may be the most important category for understanding the future evolution of core inflation,” Powell said in November. “Because wages make up the largest cost in delivering these services, the labor market holds the key to understanding inflation in this category.”

Yet even though supercore inflation is slowing, it’s still way too high for the Fed. The good news is, other wage trackers also show the growth in pay is slowing.

As a result, the rate of supercore inflation ought to continue to decline.

Want more good news? Another way of looking at supercore inflation is by measuring the rate of change in the last three months at an annualized rate.

That is, assume supercore inflation would increase over a full year at the same rate as it did from November to January.

Looked at that way, supercore inflation rose at a 3.7% annual clip in the last three months — down from a whopping 9.1% pace last June.

It’s not all good news.

The slowdown in supercore inflation last month was helped by a quirky 0.7% decline in medical costs that was tied to annual changes in seasonal adjustments. Used-car prices also showed an unusually large drop.

Don’t expect similar declines in the months ahead.

“U.S. inflation is grinding lower, but the still elevated pace of core price growth will keep the Fed on track to raise rates at least two more times this year,” said Sal Guatieri, senior economist at BMO Capital Markets.


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