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Firming Core CPI Inflation Points to Rise in 2018

We expect U.S. core CPI of around 2.1% by the end of 2018 – a modest acceleration relative to 2017.

U.S. headline Consumer Price Index (CPI) inflation rose 0.1% in December, bringing the year-over-year figure to 2.1% for 2017. While this level is in line with what we saw in 2016, the apparent stability masks a roller coaster over the year for core CPI – the component excluding energy and food prices that markets and economists follow to gauge the underlying inflation trend.

Idiosyncratic factors drove swings in core CPI

While core CPI dropped to 1.8% year-over-year in the December print from 2.2% in December 2016, most of the deceleration happened between March and July, driven to a large extent by idiosyncratic shocks. For example, core CPI dropped by 0.12% in March because of a massive one-off drop in wireless prices. Overall, inflation was slow in the first half of 2017 before bouncing back nicely in the second, ending 2017 on a firm note with December’s 0.3% month-over-month bump in core CPI. This was the second-largest increase of the year and lent support to an annualized rate of 2.25% core CPI for the second half.

Used cars were one of the largest contributors to December’s rise, with a 1.4% monthly increase directly related to the roughly 400,000 cars lost during the hurricane season. Taking out the impact of car prices, core CPI for the past six months rose at a 2.1% pace. This trend is in line with where we see core CPI heading for 2018.

What’s ahead for 2018?

Indeed, we expect core CPI of around 2.1% by the end of 2018 – a modest acceleration relative to 2017. Similarly, we expect the Federal Reserve’s preferred measure of inflation, core personal consumption expenditure (PCE), to accelerate as well, ending the year at around 1.75%, 25 basis points below its target.

A few potential tailwinds could materialize, pushing inflation above our base case. The general strength of the global economy, a weaker dollar and the recent increase in energy prices are all pointing toward higher import prices, which would feed into goods inflation. And last but not least, tax reform (which is mostly tax cuts) could stimulate an economy with limited spare capacity and trigger an acceleration of inflation.

Investment implications

Even if inflation fails to reach the Fed’s 2% target, we believe it should be sufficient to allow for three rate hikes in 2018. But with 10-year and 30-year inflation breakeven rates at 2% and running very close to the core CPI trend, we don’t see much inflation risk being priced by market participants.

Read PIMCO’s Cyclical Outlook for 2018, “Peak Growth, ” for more insights into global macroeconomics, policies, markets and the implications for investors.

READ HERE

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PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Irish Branch (Company No. 909462), PIMCO Europe GmbH UK Branch (Company No. BR022803) and PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Italian Branch, Irish Branch, UK Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority; and (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication.| PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2) . The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser.

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