U.S. Federal Reserve officials suspected the fight to lower inflation would be difficult and have been reluctant to declare success even as price increases have slowed.

The data from December showed why.

Overall consumer price inflation jumped, while a measure of underlying inflation fell. Producer prices, the costs that figure into what consumers eventually pay, dropped, and an indicator of the margins added by retailers fell sharply – a possible sign of developing price competition.

But shelter costs keep rising, as do prices charged for an array of services like auto insurance. An Atlanta Fed wage tracker recently showed bigger pay raises for people remaining in their jobs, a finding that runs counter to the notion that the labor market was settling down after a period marked by high wage gains.

Add it up and Fed policymakers say they still need more evidence to convince them that inflation will return to the U.S. central bank’s 2% target and stay at that level before they commit to interest rate cuts that financial markets expect to begin perhaps as early as March.


While some inflation factors have turned decisively in the Fed’s favor, others remain unresolved.

The central bank’s next policy meeting is scheduled for Jan. 30-31. Officials are expected at the end of that meeting to keep the Fed’s benchmark overnight interest rate steady, as they have since July, in the 5.25%-5.50% range.

Comments last week by Fed Governor Christopher Waller show the two overarching ideas that will frame the debate as policymakers consider when to start reducing borrowing costs that rose at a record pace over 2022 and 2023 to cool the worst inflation outbreak since the 1980s.

Inflation, Waller said, is now “within striking distance” of the Fed’s goal, with the personal consumption expenditures (PCE) price index the Fed uses as its benchmark running right at the 2% target on a six-month basis through November. Data for December will be released on Friday. On a year-over-year basis, PCE inflation is down to 2.6% from a high of 7.1% in June of 2022 and is expected to keep edging lower.

Yet even if the risk of a resurgence has diminished, “the worst thing we could have is it all reverses, and we’ve already started to cut,” Waller said. “We really want to see evidence that this progress, this trend … continues. I believe it will. We have to see that before we can start making decisions.”


What will create that conviction?

For the next few months, basic arithmetic should help as high inflation readings from early 2023 fall out of the calculations.

But Fed policymakers will try to look beyond that to see how different inflation components are behaving over shorter periods to get a sense of whether businesses really are becoming less aggressive in setting prices.

It is already happening for many goods, where prices in general fell about 1% from September through December. When volatile food and energy items are excluded, goods prices have been falling for seven months. Inventories are flush after a pandemic-era rebuild, and inventory-to-sales ratios are roughly where they were before the health crisis.

For the Fed it is a welcome return to a familiar world. Falling goods prices were a byproduct of trade liberalization in the 2000s and helped anchor low inflation through 2019, until the COVID-19 pandemic threw global supply chains into disarray, consumer goods demand jumped because of the health crisis, and prices soared. At their peak in February 2022, goods prices excluding food and energy products were rising 12.3% annually.

But policymakers also don’t want to rely on that too much, and recent developments, like the strikes by Iran-aligned Yemeni militants that have discouraged shipping through the Suez Canal and trade frictions between the U.S. and China, have raised worries about renewed price pressures.


The pandemic led to soaring home prices in parts of the U.S. and falling rents in others, but overall shelter costs rose only a tepid 1.4% over the 12 months ending February 2021, less than half the typical rate preceding the COVID-19 outbreak.

But shelter inflation then accelerated, hitting 8.2% by March of 2023. That reading has been slowing, and Fed officials remain confident shelter cost “disinflation” will continue.

Yet the process has been so slow that some policymakers consider housing costs still too sticky to rely on.

“I think in the categories of where are the dangers, this issue of housing inflation is the critical piece in the near term,” Chicago Fed President Austan Goolsbee said in an interview with Reuters earlier this month.

Real-time measures of new apartment leases show slower price increases in the pipeline, and that should eventually lower headline inflation. But some of the improvement has leveled out, and the complicated interplay between apartment and house construction, home sales, mortgage rates, and ongoing job creation and wage growth has divided top economists over how far or how fast housing inflation will slow from here.

Shelter costs account for about a third of the spending basket used for the consumer price index (CPI). While the weighting is roughly half that in the Fed’s preferred PCE price index, policymakers may remain skittish about cutting interest rates if housing inflation does not fall as anticipated.


If the last chapter of the Fed’s inflation fight comes down to one thing, it is whether the massive service sector, which accounts for about two-thirds of the economy, behaves more like airline fares or auto insurance.

When the CPI peaked above 9% in June 2022, auto insurance premium increases were responsible for about 0.15 percentage points of that change, while airfares accounted for a comparable 0.18 percentage points. But airline prices have been falling for nine months now, while auto premiums continue their upward trajectory – having risen 20% over the last year as of December and accounting for a full half of a percentage point of that month’s 3.4% inflation rate.

Services inflation outside of housing has been slowing but remains elevated, and some policymakers are concerned it may persist.

Richmond Fed President Thomas Barkin told reporters earlier this month that he sees forces pulling in both directions – competition, for example, that led a gym owner in his district to see a drop in new enrollments after a price increase, but plenty of markets where businesses still have pricing power and intend to use it.

The push and pull across industries, from small businesses to national chains, from health care to haircuts, may well set the pace for the Fed’s own decision making.

“You increase prices until you kind of get the signal from your customers and competitors … that you can’t,” Barkin said. “The COVID period was so confusing to purchasers, both individuals and institutions, it’s hard for people to get prices back into some sense of what’s normal … We’ll see how it all plays through.”

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