Weakness of core inflation to prove persistent

Fed officials have dismissed the recent weakness of core inflation, which has fallen to only 1.6% on the PCE measure, as being driven by transitory factors. Methodology changes resulted in a sharp fall in clothing prices, while the plunge in the stock in the fourth quarter pushed financial services prices sharply lower. With the stock market having rebounded close to a record high, the latter is now being reversed. Even excluding those factors, however, core inflation has still declined. That can mainly be explained by the sharp slowdown in unit labour costs growth which, on past form, suggests that core inflation has even further to fall. Admittedly, the prospect of across-the-board tariffs on Chinese imports could see a spike in consumer goods prices later this year. But the Fed would be more concerned by the potential hit to real activity. With GDP growth already set to slow below 2% in the second quarter, the upshot is that we still expect the Fed to begin cutting interest rates before the end of this year.