CPI vs PCE to Create Inflation Confusion

The Fed may have a difficult time determining its progress against inflation later this year, as the two biggest inflation indicators contradict each other. The Federal Reserve prefers the Personal Consumption Expenditures index or PCE as a basis for its 2% inflation target. But due to the differences between the PCE and the Consumer Price Index or CPI, they might reverse their roles and cause confusion.   Hi, I'm Kathy Fettke and this is Real Estate News for Investors. Please don't forget to subscribe to our podcast, and leave us a five-star review if you like what you hear!   The CPI is more closely watched by average Americans, and it's been the one to show the highest level of inflation. But according to an analysis in the Wall Street Journal, as inflation subsides, it could drop below the PCE, making it difficult for the Fed to explain rate hikes based on the PCE. (1)   Difference Between the CPI and the PCE Indexes   Economists are betting that the CPI will fall to 2.6% in October while the PCE will drop to about 2.8%. Barclays inflation expert, Michael Pond, says: "That will leave market participants looking at low inflation while the Fed looks at a measure that tells them they need to continue to be quite hawkish."    The two indexes perform differently because they place different amounts of emphasis on various components of the economy. For example, housing makes up 33% of the CPI which is more than twice the size of the housing component in the PCE. Shelter inflation is rising about 8% per year right now in both indexes, so the strength in housing in pushing the CPI higher. As the Journal reports, it contributed 2.5 percentage points to the CPI's January reading of 6.4% while it only contributed 1.2 percentage points to the PCE's January report.   Piper Sandler economist Jake Oubina expected CPI shelter inflation to fall from 8.1% in March to 5.5% in December. If that happens it will weigh more heavily on the CPI, bringing the total amount of inflation down by a larger percentage than the PCE.    Economists also believe that medical care costs will play a role in this disconnect between the CPI and PCE. Those costs are expected to rise this year. They make up 16% of the PCE and just under 7% of the CPI. If they do go higher, that will put more pressure on the PCE than it does on the CPI.    There's also concern that energy costs will help invert these two indicators because they make up 6.9% of the CPI and just 4% of the PCE. If energy costs keep falling, that will exert more deflationary pressure on the CPI.    CPI Could Drop Lower than the PCE   City economist Veronica Clark told the Journal that a combination of the factors could bring the CPI down to 3.2% by June while the PCE is closer to 3.6%. She expects the gap to be even bigger for core inflation. She says: "For the Fed, the message could be kind of tricky. They target PCE, technically, so as long as the PCE remains high, they can't declare victory."    You'll find a link to the Wall Street Journal article in the show notes at newsforinvestors.com. We also invite you to become a RealWealth member. It's free and will give you full access to all our real estate data and resources, including property tours in several markets over the next few months. You'll find information on those tours inside the Realty Portal on our website. I would also like to remind everyone to please subscribe to the podcast if you haven't done so already and leave a review!   Thanks for listening, Kathy Fettke   Links:   1 -  https://www.wsj.com/articles/fed-might-be-winning-inflation-fight-depending-on-index-used-56d3e31b?mod=pls_whats_news_us_business_f