US inflation pressures continue to mount despite the stronger USD and lower oil prices

Today's CPI report showed more signs that domestic inflation pressures continue to mount, despite the stronger USD and lower oil prices. As the impact of the stronger USD and the slump in energy prices begins to wane next year, inflation will climb even higher.

Headline CPI inflation took another step upwards in November, driven by drop in energy prices late last year. The headline rate edged up from 0.2% in October to 0.5% y/y, the highest since December. The recent low was -0.2% in April.

"Headline CPI inflation is likely to rise more quickly in coming months. We currently project a pick upto around1½% y/y in January, although that forecast depends on a stabilisation in energy prices", says Nordea Bank.

Core CPI inflation edged up from 1.9% to 2.0% y/y in November, the fastest pace since May 2014. Continuation of the 0.2% per month trend would take the core rate to 2.2% y/y by December. So far this year the core CPI is up 2.1%, a significant acceleration from the 1.6% pace in 2014. The acceleration in the core CPI is fairly broad-based, see below for details.

Core CPI services price inflation jumped to a 7-year high in November. A pickup in non-shelter core services price inflation is likely reflecting rising labour cost pressures. After all, unit labour costs were up 3% y/y in Q3.

Core goods price inflation remains negative. However, that fact that core goods prices are not falling as quickly as they did a year ago suggests that the pass-through from changes in the USD to US consumer prices continues to be rather limited.

The broad-based acceleration in core services prices indicates that once the impact of the stronger USD and lower commodity prices fades inflation will climb even higher.

Core PCE inflation remains significantly weaker than core CPI inflation. Unusually low health care inflation has held down core PCE inflation over the last few years, due to a combination of policy-related restraint on prices and slowing wages in the sector. However, this looks likely to change in coming quarters.

Today's CPI report does not change the argument for gradualism after tomorrow's likely lift-off in Fed rates.

"We believe rising inflation pressures will imply that the pace of Fed tightening during 2016 will be faster than is currently priced in by markets. At present, the market is priced for about two hikes in 2016, compared with four hikes in the FOMC's dot plot", added Nordea Bank.