Inflation Cools as Economic Activity Slows at the End of Q1

Key Takeaways:

• The Consumer Price Index (CPI) increased 0.1 percent in March, according to the Bureau of Labor Statistics (BLS). Over the year, prices rose 5.0 percent, the slowest annual inflation rate since May 2021. Much of the softness was due to a 3.5 percent decline in energy prices. Core CPI (excluding food and energy), rose a stronger 0.4 percent in March and 5.6 percent compared to a year ago, an acceleration of one-tenth. The travel industry posted large price hikes as airline fare was up 4.0 percent and prices for lodging away from home (including hotels and motels) rose 3.1 percent. Shelter costs slowed as both rent of primary residence and owners’ equivalent rent increased 0.5 percent over the month.
• The Producer Price Index (PPI) declined 0.5 percent in March after a flat month in February, bringing the annual inflation rate down to 2.7 percent, according to the BLS. Core PPI (less food, energy, and trade services) rose 0.1 percent over the month and 3.6 percent over the year. Final demand for services prices were down 0.3 percent.
• Retail sales and food services declined 1.0 percent in March, though February’s figure was revised upward modestly, according to the Census Bureau. Sales were down or roughly flat in most major categories, including a 2.1 percent decline in spending at building materials and garden equipment & supply dealers and a 5.5 percent pullback in gas station sales. Restaurant sales ticked up 0.1 percent after a 1.6 percent decline in February. Nonstore sales rose 1.9 percent. Core retail sales, which exclude food services, autos, building supplies, and gas stations, declined 0.3 percent after a strong start to the quarter.
• Industrial production, a gauge of output in the manufacturing, utility, and mining sectors, increased 0.4 percent in March, according to the Federal Reserve Board. However, the increase was due entirely to an 8.4 percent surge in utilities output stemming from more seasonally normal weather. Both manufacturing and mining output declined 0.5 percent.
• The National Federation of Independent Business (NFIB) Small Business Optimism Index declined 0.8 points to 90.1 in March. On net, 15 percent of firms expect real sales to be lower in the next six months, a 6-point drop and the lowest level since August 2022. Additionally, a net 2 percent of firms reported that now is a good time to expand, a decline of 4 points and the lowest level since 2009, even including the initial COVID shock. Perhaps reflecting recent bank turmoil, a net 9 percent of firms reported that credit was harder to get, an increase of 4 points and the highest level since 2012.
• The minutes from the Federal Open Market Committee (FOMC) March 21-22 meeting showed that “several” participants considered holding the federal funds rate steady following multiple bank collapses. The notes also stated that “some” participants would have supported a 50-basis point hike had it not been for the banking turmoil. The Committee ultimately settled on a 25-basis point hike noting that the banking events would have the effect of tightening credit conditions. Interestingly, the minutes noted that Fed staff now expect a “mild recession.” The Summary of Economic Projections had already implied a recession is possible due to the projected increase in the unemployment rate.

Forecast Impact:

Inflation data was notably cooler in March, largely in line with our expectations. While part of the weakness in headline CPI and PPI was due to a pullback in energy prices that we believe is likely to at least partially reverse in April following OPEC’s announced cuts to oil production, it’s notable that inflationary pressures appear to be less broad-based than before. The Cleveland Fed’s measure of trimmed-mean CPI, which excludes the 8 percent of CPI components with the highest and lowest one-month price changes and is thus a systematic way of removing volatile categories, increased at only a 2.8 percent annualized rate, the slowest since February 2021. Additionally, the slowdown in rent and OER is notable as these categories account for more than a third of the CPI calculation. While we have long predicted that shelter costs would slow considerably sometime this year as slowing home price and rental growth eventually filter through into the official government calculation, it’s also possible that the especially hot readings at the beginning of the year are just being smoothed out in March’s data and the peak for shelter inflation is still a few months away.

Moderating inflation coincides with a broader slowing of economic activity. The weakness in core retail sales provides additional evidence that, despite starting 2023 strong, the economy lost momentum toward the end of the quarter (though we still expect Q1 consumption to be strong based on January and February data). Manufacturing output also remained weak and the NFIB survey foreshadowed that business loans may be more difficult to get following recent banking turmoil. While it’s still too early to judge the full impact of recent bank failures, our forecast had already assumed tighter credit conditions coinciding with a modest recession later this year.

Nathaniel Drake
Economic and Strategic Research Group
April 14, 2023

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