In the PCE, however, medical care will not only be positive but could also accelerate as higher input costs like pay and equipment begin to filter through.
“You really haven’t seen the full force of the increase in labor costs that we’ve seen in the health care sector over the past two years,” said Sarah House, senior economist at Wells Fargo & Co.
Smaller Share, Smaller Deceleration
The other big reason why core CPI is seen decelerating much quicker than core PCE in 2023 is because more generally, the categories that will help drag down the CPI have smaller weightings in the PCE.
Take housing for instance. The so-called shelter category makes up about a third of the overall CPI and about 40% of the core measure. That makes sense given housing tends to be households’ single-biggest monthly expense.
The run-up in rental prices has filtered into the official government measures with a lag. Similarly, the rapid deterioration in the housing market seen over 2022 will also take time to be reflected in the figures. But when they do, the impact on the CPI will be swift.
The effect on PCE, despite similar measurement, will be much smaller, given the housing components have roughly half the significance they do in the CPI.
“That’s probably the biggest driver of the divergence in the outlook for next year,” said Schwartz, who sees core CPI at 3.5% at the end of 2023 and core PCE at 3.1%.
A similar dynamic is expected with autos. Used vehicles have already turned over, falling four straight months in the CPI. But the category has a smaller weighting in the PCE index.
Food & Financial Services
Inherently there are also a few categories in the core PCE that just really aren’t reflected in the core CPI. One of those categories is food services, accounting for about 7% of the core PCE.
Another is financial services, which measures what consumers may pay a financial advisor or the implicit costs banks charge to hold deposits. The grab-bag nature of it led several economists to emphasize how difficult it is to forecast.
Credit Suisse’s Schwartz said the best predictor tends to just be asset prices. Inflation Insights’ Sharif said his general rule of thumb is when interest rates are rising, these costs tend to add to core inflation.
The underlying distinctions in the two overall price gauges have mattered less amid extremely high inflation. But next year may prove to be different.
“As inflation comes down and the Fed is trying to really calibrate policy back to its inflation target while trying to limit the damage elsewhere to the economy, I think the different measurements will come more into the fore,” House said.
This article was provided by Bloomberg News.