U.S. Inflation continue to increase in January

Inflation rose to 2.5% year-over-year in January, marking the fastest pace in the headline index since March 2012. On a seasonally adjusted basis, prices rose 0.6% on the month from the previous month. Consumers paid more for gasoline, shelter, apparel, and new vehicles in January. The price of gasoline was responsible for about half of the 0.6% m/m advance in January reflecting the pass-through from higher price for crude oil.

Food prices fell for the fifth consecutive month on a year-over-year basis, driven down in January by a 4.9% y/y decline in the price of fruits and vegetables. Stripping away volatile food and energy prices, core CPI rose 2.3% y/y in January, with the index rising 0.3% on the month.

Headline inflation in January was well above 2% for the second consecutive month, owing largely to a much anticipated bump from the rising energy prices. We expect that higher energy prices will remain a key driver behind the rise of headline inflation in 2017.

The continued increase in underlying inflation, driven in part by firming wage growth, will be interpreted by the Federal Reserve as a sign of a decreasing economic slack, and therefore confirm the need for a tightening of monetary policy. We expect the Fed to raise interest rates at least once in the first half of 2017 followed by another raise in the second half in order to prevent a persistent overshoot of its 2% target.