Inflation: "Core cuts both ways"

In last week's "Paging Paul Krugman: The Poor and Middle Class Pay the Inflation Tax" I said:

Professor Krugman has stopped saying that QE2 doesn't contribute to commodity inflation.
A good thing. He was starting to sound like a moron.
His latest offering was to the effect that headline inflation would be down in the next report because of the 10% decline in gasoline prices. He didn't mention that 'headline' has already bled into 'core', which will be higher.
Or that he has been arguing against the mere mention of the headline number....

Here's the Federal Reserve Bank of Atlanta's Macroblog (June 13) on one factor that would tend to buttress Dr. K's argument:

With the six-month average of annualized headline inflation running just over 5 percent, this Wednesday's consumer price index (CPI) report looms a little larger than usual. While it is dangerous to predict such things, there is every reason to believe that the measured increase in CPI inflation for May could be quite low. And there is every reason to believe that this softness will persist into June.

The reason is quite simple. Movements in gasoline and fuel prices really do push around the headline inflation number, and at long last it looks like that movement is in the downward direction. Here's the relevant picture:

Let's assume that, annualized, CPI excluding food and energy rises 2.1 percent, as it has so far this year, and food and nongasoline energy prices each rise at 5 percent. Then when you plug in gasoline prices already realized for May and EIA predictions for June, you get a 0.4 percent rise in the headline CPI in May and a 0.7 percent decline in June (both rates annualized).

Despite some probable relief on the headline inflation number, I remain aware of what that relief means and what it does not....MORE

One area where the CPI is going to get interesting is the method of accounting for housing which accounts for around a quarter of the index. The CPI uses "Owner's Equivalent Rent" rather than house prices. During the bubble this tended to lower reported inflation, as rents lagged price appreciation and disguise the asset bubble. Today, while house prices are still declining, rents appear to have bottomed and are in fact turning up in quite a few markets.
There is a move afoot to change the methodology to show a lower reported inflation. Stay tuned.

In the meantime here's a New York Fed staff report from last year:

The Measurement of Rent Inflation