Fed’s dilemma – US core inflation flying low

US Core PCE inflation increased only 0.11% m/m in April from 0.13% in March, pushing the y/y reading down to 1.2%. This contrasts with the core CPI inflation reading, which rose 0.26% m/m (and 1.8% y/y). 

The main difference is that the CPI index has a bigger weight for housing (rents and owner-equivalent rents) than the PCE. 

In April, due to a difference in methodology, medical services rose less in the PCE than in the CPI index. So far this year, core PCE inflation has averaged only 1.3%, and 1.5% over the past five years, undershooting the Fed's 2% target significantly. 

PCE inflation is the Fed's preferred inflation measure, but the core reading (ex-food and energy) is particularly scrutinised to gauge the underlying trend, particularly inflation's demand-based aspect. 

The view is that volatile elements affecting the headline, in particular energy prices lately, will gradually wane and the PCE index will converge towards the underlying trend - core PCE - over time.