Question

Based on the article below that was written by Jeff Cox of CNBC and published on February 14, 2018, respond to the following questions:

a) What is the Consumer Price Index (“CPI”)?

b) Identify some of the uses of the CPI?

c)“The Consumer Price Index, a key indicator of inflation trends, jumped 0.5 percent in January….” —what does that mean?

d) If the CPI increased from 220 in December 2016 to 230 in December 2017, what would that be telling you?

e) The author states “A strong rise in inflation would send borrowing costs higher and could cut into corporate profits?” What is the reasoning behind that assertion?

Consumer Prices Jump Much More Than Forecast, Sparking Inflation Fears

The Consumer Price Index, a key indicator of inflation trends, jumped 0.5 percent in January, well above market expectations.

Markets reacted sharply to the news, with stocks sliding and government bond yields rising.

The Fed is watching inflation closely, so the report could add fuel to interest rate hikes.

U.S. consumer prices rose considerably more than expected in January, fueling fears that inflation is about to turn dangerously higher.

The Consumer Price Index rose 0.5 percent last month against projections of a 0.3 percent increase, the Labor Department reported Wednesday. Excluding volatile food and energy prices, the index was up 0.3 percent against estimates of 0.2 percent.

The report indicated that price pressures were "broad-based," with rises in gasoline, shelter, clothing, medical care and food.

Markets reacted sharply to the news. The Dow opened more than 100 points lower, but reversed those losses after the first half-hour of trading. Government bond yields also turned higher, with the benchmark 10-year note most recently trading near 2.88 percent, a gain of about 3.8 basis points.

Investors also began to price in the likelihood that the Federal Reserve will raise interest rates at least three times this year.

"Faster economic growth over most of the past year has tightened labor and product markets and helped to boost prices at a faster pace," David Berson, chief economist at Nationwide, said in a note. "We expect real GDP growth this year to be around 3 percent — faster than trend and supportive of higher inflation."

Headline CPI rose 2.1 percent on an annualized basis against expectations of 1.9 percent. Core CPI increased 1.8 percent vs. estimates of 1.7 percent.

Investors were watching the report closely after fears of surging inflation helped send the stock market lower and bond yields higher. A strong rise in inflation would send borrowing costs higher and could cut into corporate profits.

"Overall we think the increase in core CPI inflation in January is a sign of things to come over the rest of the year," said Michael Pearce, senior U.S. economist at Capital Economics.

Federal Reserve policymakers have a goal of 2 percent inflation, which they believe is a sign that the economy is strong but not moving too quickly. The gauge is not the central bank's most closely watched measure — that would be the personal consumption expenditures index — but still could figure into decisions on interest rates.

Following the release, markets priced in a higher possibility for a third rate hike before the end of the year. The chances are now at nearly 62 percent for a move in December, up from a coin-flip 50 percent the day before, according to the CME's FedWatch tracker.

The Fed currently has its benchmark rate pegged at 1.25 percent to 1.5 percent, which could be seen now as too low if the inflation pace is sustainable.

"The worry of the markets is not that inflation is becoming a big problem, ... it is that the Fed is now forced to play catch up at the same time they are shrinking their balance sheet," said Peter Boockvar, chief investment officer at Bleakley Advisory Group. "If the Fed wasn't so scared of their own shadow in 2015 and 2016 and hiked rates three times each year, we wouldn't be having the same conversation."

Markets also pushed up the probabilities for a March rate hike — already considered a near-certainty — and moved up the likelihood of a move in June. Traders also see about a 22 percent chance of a fourth quarter-point increase.

Most individual measures with the CPI showed gains, with a spike in fuel oil of 9.5 percent and a gain of 5.7 percent in gasoline leading. Gasoline is up 8.5 percent over the past year while fuel oil has surged 22.5 percent.

Food prices rose 0.2 percent, with food away from home up 0.4 percent, its biggest gain in a year and part of a 2.5 percent annualized gain. Fruits and vegetables increased 0.5 percent, with fruit up 1.9 percent and vegetables down 1.2 percent.

A 1.7 percent jump in clothing costs also stood out.

Answer 1

a) Consumer price index is the change in the price of the market-based basket of goods and services purchased by households.

b) uses of CPI is that it is a measure of change in price which is an indicator of the cost of living. It is used to identify deflation and inflation periods and it is an ideal measure of standard of living.

c) CPI jumped 0.5% in January means that the price level increase in January by 0.5% compared to some previously set base period prices. The price level of the predetermined basket of goods and services has changed which is captured by CPI.

d) Compared to some base period with CPI 100, the value has increased to 220 in December 2016 and compared to the same base period it has increased by 230. Now comparing 2016 and 2017, the CPI has increased by the rate of change in CPI is 4.5%