The battle towards inflation is way from over

A grocery shopper searches for vegetables at the Hannaford Supermarket in South Burlington, Vermont, July 1, 2023.

Robert Nickelsberg | Getty Images

Don’t get your party hats on just yet: despite recent signs of slowing inflation, the struggle to contain the meteoric price increases of the past three years is far from over.

Financial markets drew optimism from two reports last week that showed the rate of growth in both the prices consumers pay at the checkout and the prices businesses pay for the goods they use have hit their lowest levels in several years .

However, these data points reflected relative rates of change and did not capture the overall increase that led to the highest level of inflation in more than 40 years. In addition, there are still worrying undercurrents in the economy, such as rising fuel prices and a congested real estate market, that could cause problems in the future.

“No win laps. No mission accomplished. Our work is not done yet,” Jared Bernstein, chairman of the White House Economic Advisory Council, said during a CNBC interview with Squawk Box Monday morning. “But we’re very pleased that American households have some breathing room.”

The consumer price index, a widely used measure tracking dozens of goods and services across multiple sectors, rose just 0.2% in June, bringing the annual rate to 3.1%. That latter figure is well below its peak of 9.1% a year ago, its highest in nearly 41 years and its lowest since March 2021.

Also last week, the Labor Department reported that the PPI rose just 0.1% in June and the same amount on an annualized basis. The 12-month PPI peaked in March 2022 at an annual rate of 11.6%, the highest of any data from November 2010.

Sharp declines in both stocks raised hopes that the central bank could ease its rate hikes and tightening monetary policy implemented since early 2022 as inflation nudges closer to the Federal Reserve’s 2 percent target.

A temporary respite?

“Cooling down of inflation. Slower but still positive employment growth. These are the things that soft landings are made of,” Citigroup economist Andrew Hollenhorst said in a note. “Near-term price inflation can do little to counter the mounting hopes of Fed officials and the market for a positive outcome.”

But Citi’s economics team is concerned that the ideal conditions, which include resilient consumer spending, stronger supply chains, and falling prices in key areas like energy and vehicles, may not last.

“Tight labor markets, high wages and upside risks to inflation in accommodation and other services mean we don’t share this optimism,” Hollenhorst added. “Without a tightening of financial conditions, inflation could pick up again in early 2024.”

For their part, Fed officials have indicated that they expect their key interest rate to rise by at least half a percentage point by the end of the year. Chair Jerome Powell has repeatedly warned against reading too much from a few months of positive inflation data, noting that history shows such moves can be mere fallacies.

Warning signs abound

There is certainly reason for caution, if not outright skepticism, about inflation developments.

The easiest to point out is that while the CPI may be falling sharply when all elements are factored in, the performance is less impressive when excluding volatile food and energy prices. The energy sector has collapsed by almost 17% in the last year and can recover quickly.

So-called core inflation rose 0.2% in June and was at an annualized rate of 4.8%, much higher than the Fed had expected.

Another focus is on residential construction.

Central to the Fed’s expectation that inflation will ease is the belief that rental costs will gradually fall after a house price boom in the early days of the Covid pandemic. However, accommodation costs rose another 0.4% in June and are now 7.8% higher than a year ago. That’s just below the peak from earlier in the year and still close to the highest since the early 1980s.

Looking at prices from a longer perspective, despite the recent easing, the CPI is still about 18% higher than three years ago.

There are other annoying points.

Health insurance costs have fallen nearly 25% over the past year, thanks in large part to a nebulous adjustment the Bureau of Labor Statistics is making in this category. The adjustment ends in a few months, which means that while this category is a small contributor to the CPI weighting, it could become a larger factor.

Inflation has caused much suffering

Fed officials have vowed not to be complacent about inflation and have repeatedly expressed concern about the impact on lower-income families and workers.

Small businesses have also been hit hard by both rising prices and the higher interest rates used by the Fed in its efforts to restore price stability.

“Inflation has certainly changed the cost structure for many small businesses in some cases, perhaps permanently,” said David Cody, co-founder and co-CEO of NEWITY, which began as a channel for Paycheck Protection Program loans during the coronavirus crisis now focused on providing small business lending solutions.

“Not only are there headwinds to growth as things slow down, which is what’s happening right now, but there are also high absolute rates and pricing pressures on inputs,” he added.

Coty said the current environment is extremely challenging for small business financing and he does not expect benefits from lower inflation for a while.

“There needs to be some movement to significantly change the landscape for these small businesses considering there has been so much headwind in recent years, including the pandemic,” he said.

Of course, there is also plenty of evidence that inflation is going in the right direction.

The easing of supply chain problems is probably the biggest positive factor. A New York Fed indicator of global supply chain pressures is near its lowest level since 2008.

Also, as consumers use up excess savings accumulated by trillions in tax and monetary stimulus, demand is likely to slow, putting pressure on some key categories. These trends could prompt the Fed to take their foot off the brakes.

“Underlying improvement in both core goods and services inflation won’t stop the Fed from raising rates later this month, but if the trend holds, it should convince the Fed not to move on thereafter and eventually with the to start cutting interest rates again in the first half of next year,” wrote Paul Ashworth, chief North America economist at Capital Economics.

The Commerce Department will take a closer look at the impact of inflation on spending on Tuesday.

Retail sales are expected to grow 0.5% in June, an important reading as it is not adjusted for inflation. If monthly spending actually exceeds the magnitude of price increases, that could be inflationary in itself.

“With the Fed temporarily pausing rate hikes, the US economy has shown resilience on sustained consumer spending, but it continued that trend.” [at] “The current interest rate could lead to an elevated new normal level of spending,” said Kavan Choksi, managing director of KC Consulting.

“The reality is that current inflation rates are still having a negative impact on consumers,” he added. “Even if we are on the right track, we still have a long way to go.”

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