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A woman shops for clothing at the JC Penney Co. store inside the Roosevelt Field Mall in Garden City, New York. (Saul Martinez/Bloomberg)
A woman shops for clothing at the JC Penney Co. store inside the Roosevelt Field Mall in Garden City, New York. (Saul Martinez/Bloomberg)

Weak U.S. retail sales, consumer prices put spotlight on Fed Add to ...

U.S. retail sales in May recorded their biggest drop in 16 months and consumer prices unexpectedly fell, suggesting a softening in domestic demand that could limit the Federal Reserve’s ability to continue raising interest rates this year.

The Fed is expected to increase borrowing costs later on Wednesday, but the signs of moderate consumer spending and retreating inflation pressures could worry policymakers who have previously viewed the softness as transitory.

“It won’t stop the Fed from hiking interest rates later today, but it increases the downside risks to our forecast that there will be a further two rate hikes in the second half of this year,” said Paul Ashworth, chief U.S. economist at Capital Economics in Toronto.

The Commerce Department said retail sales fell 0.3 per cent last month amid declining purchases of motor vehicles and discretionary spending after an unrevised 0.4 per cent increase in April. May’s decline was the largest since January 2016 and confounded economists’ expectations for a 0.1 per cent gain.

Retail sales rose 3.8 per cent in May on a year-on-year basis. While some of the drop in monthly retail sales reflected lower gasoline prices, which weighed on receipts at service stations, details of the report were generally weak.

Excluding automobiles, gasoline, building materials and food services, retail sales were unchanged last month after an upwardly revised 0.6 per cent rise in April. These so-called core retail sales correspond most closely with the consumer spending component of gross domestic product and were previously reported to have increased 0.2 per cent in April.

Consumer spending accounts for more than two-thirds of the U.S. economy and last month’s weak core retail sales reading could temper expectations for a sharp acceleration in economic growth in the second quarter. The economy grew at a 1.2 per cent annualized rate in the first quarter, held back by a near stall in consumer spending and a slower pace of inventory investment.

Output increased at a 2.1 per cent pace in the October-December period. The Atlanta Fed is forecasting GDP rising at a 3.0 per cent annualized rate in the second quarter.

In a separate report, the Labor Department said its Consumer Price Index dipped 0.1 per cent, weighed down by declining prices for gasoline, apparel, airline fares, communication and medical care services, among others. The CPI rose 0.2 per cent in April.

It was the second drop in the CPI in three months. In the 12 months through May, the CPI increased 1.9 per cent, the smallest increase since last November. The CPI rose 2.2 per cent in the 12 months through April.

The Fed has a 2 per cent inflation target and tracks an inflation measure which is currently at 1.5 per cent.

Retreating inflation pressures

While the U.S. central bank is expected to raise interest rates by 25 basis points on Wednesday, the second hike this year, the weakness in inflation and retail sales, if sustained, could put further monetary tightening in jeopardy.

The dollar fell to a seven-month low against a basket of currencies on the data, while prices for U.S. Treasuries rose. U.S. stocks were trading slightly lower.

The year-on-year gain in the CPI in May was still larger than the 1.6 per cent average annual increase over the past 10 years. Economists polled by Reuters had forecast the CPI unchanged last month and advancing 2.0 per cent from a year ago.

The so-called core CPI, which strips out food and energy costs, rose 0.1 per cent in May after a similar gain in April. The core CPI increased 1.7 per cent year-on-year, the smallest rise since May 2015, after advancing 1.9 per cent in April.

“It will be difficult to continue characterizing the recent inflation pullback as transitory,” said Chris Low, chief economist at FTN Financial in New York.

Last month, rental costs increased 0.3 per cent, matching April’s gain. Owners’ equivalent rent of primary residence advanced 0.2 per cent after a similar increase in April.

Gasoline prices recorded their largest drop since February 2016, while food prices rose for a fifth straight month.

In the retail sales report, auto sales fell 0.2 per cent in May and receipts at service stations dropped by the most since February 2016.

Department store sales recorded their biggest drop since July 2016. Department store sales are being undercut by online retailers, led by Amazon.com. That has led some retailers, including Macy’s, Sears and Abercrombie & Fitch to announce shop closures.

Sales at online retailers increased 0.8 per cent last month after rising 0.9 per cent in April. Sales at electronics and appliance stores suffered their largest drop since March 2010. Americans also cut back on spending at restaurants and bars, as well as at sporting goods and hobby stores.

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