Low Inflation Signals Weak Economy

The Consumer Price Index rose 0.2% in May, less than the expected 0.3%.

The CPI reflects changes in the prices paid by consumers for a basket of goods and services intended to reflect what Americans buy in a given year. This includes things like food, housing, clothing, medical care, and transportation.

The price of gas and food are often backed out of the CPI to screen spikes and drops in the price of oil or crops. The energy portion of the index rose 1.2%, reflecting the cost of gas and oil.

The Federal Reserve tracks CPI closely. Aside from using interest rates to stimulate the economy, the Fed also uses them to counter inflation.

Weak employment numbers, among other factors, encouraged the Fed to keep rates low, a decision reinforced by the CPI report. Lower than expected inflation means the overall economy could be cooling down.

Yesterday the Fed said it would not increase interest rates, and it expected GDP to be below its previous forecast. Sharper than expected CPI growth earlier in the year wasn’t enough to force the Fed’s hand, and today’s CPI report makes Fed rate increases less likely. This could change if the CPI trend reverses through the summer and employment picks up.