• The overall CPI rose 0.3% in January, with core prices flat.
• Year-over-year overall CPI inflation was 1.4%, unchanged from December; core inflation was also 1.4%, down from 1.6% in December.
• Inflation will temporarily move above 2% in the second quarter because of comparisons with the very weak second quarter of 2020, but will slow in the second half of this year.
• With inflation expected to remain low, the Fed will keep monetary policy very aggressive into 2021.

The consumer price index (CPI) rose 0.3% in January from December. A 3.5% increase in energy prices over the month, including a 7.4% increase in gasoline prices, pushed overall prices higher. The core index, excluding volatile food and energy prices, was flat in January. Food prices rose a modest 0.1% in January. Services prices excluding energy services were flat in January. The overall CPI increased 0.2% in December, while the core CPI was flat.

On a year-ago basis overall inflation was 1.4% in January, the same pace as in December. Overall year-over-year inflation fell to 0.1% in May as aggregate demand in the economy plunged and has slowly moved higher since then. Year-over-year core inflation was also 1.4% in January, down from 1.6% in December. Core inflation was slightly above 2% in late 2019 and early 2020, and then was between 1.2% and 1.4% in April through June because of the pandemic. It then accelerated slightly to 1.6% to 1.7% in the second half of 2020, before falling somewhat in January.

Both overall and core Inflation will accelerate to 2% or slightly higher on a year-ago basis over the next few months because of comparisons with the spring of 2020, when prices fell outright during the Viral Recession. But that will be transitory, and inflation will slow to below 2% year-over-year in the second half of 2021.

Continued weak demand for many goods and services, excess capacity in wide swathes of the economy, and low wage pressures from elevated unemployment will all keep inflation low over the next couple of years, especially for services, which make up more than one-half of consumer spending. Inflation will be stronger in a few areas with elevated demand, such as building materials and food purchased for home use.

The Federal Reserve will maintain its very aggressive monetary policy stance over the next few years; Fed officials have made it clear that transitory higher inflation in the second quarter will not deter them. The central bank has set an inflation objective of 2% using a different measure, the personal consumption expenditures price index, which tends to run a bit slower than CPI inflation.

Given that inflation has been below this 2% objective for most of the past decade, the Fed would like to see inflation move above 2% for a few years so that it averages around 2%. Given that, the Federal Open Market Committee has said that it does not expect to increase the federal funds rate until inflation has clearly hit 2% using the PCE price index. The Fed has also said that it does not expect to reduce its purchases of long-term Treasuries and mortgage-backed securities until inflation has started to accelerate and the labor market has made significant progress toward full employment. PNC expects the Fed to maintain these purchases at their current level of around $120 billion per month through the rest of 2021.