Low inflation gives Fed more flexibility

The fall in inflation to well below the Fed's 2% target rate is another reason why the central bank will be in no hurry to slow the pace of its monthly asset purchases. Headline CPI inflation fell to only 1.1% in April. Admittedly, the decline was mainly due to the most recent drop back in gasoline prices. But core CPI inflation has also been falling, albeit more gradually. Inflation is also even lower on the Fed's preferred PCE deflator measures. With falling commodity prices pushing finished goods prices lower and moderate gains in unit labour costs constraining services inflation, it is possible that core inflation will fall further in the second half of the year. Nevertheless, we still anticipate that the improving real economy will prompt the Fed to curb its $85bn per month of asset purchases before year-end.