WASHINGTON (AP) – US inflation shows signs of entering a more stubborn phase this will likely require drastic action by the Federal Reserve, a shift that has frightened financial markets and increases the risks of a recession.
Some of the long-standing factors of rising inflation – rising gas prices, growling supply chains, rising used car prices – are fading. Yet the underlying measures of inflation are indeed getting worse.
The continuing evolution of the forces behind an inflation rate close to the high of the past four decades has made it more difficult for the Fed to keep it in check. Prices are no longer rising as some categories have skyrocketed. Conversely, inflation has now spread more widely in the economy, fueled by a strong labor market this is increasing payroll, forcing companies to raise prices to cover higher labor costs and giving more consumers the means to spend.
On Tuesday, the government said inflation rose by 0.1% from July to August and 8.3% compared to a year ago, down from the high of the last four decades in June of 9.1%
But excluding the volatile categories of food and energy, so-called core prices rose an unexpectedly strong 0.6% from July to August, after a more modest 0.3% increase the previous month. The Fed closely monitors core prices and the latest data has heightened fears of an even more aggressive Fed and plunged stocks. with the Dow Jones falling over 1,200 points.
Base price data reinforced fears that inflation has now spread to all corners of the economy.
“One of the most remarkable things is how large the price gains are,” said Matthew Luzzetti, chief US economist at Deutsche Bank. “The underlying trend in inflation has certainly not shown any progress towards moderation so far. And this should be a concern for the Fed as price gains have become increasingly demand-driven and therefore are likely to be more persistent. “
Demand-driven inflation is a way of saying that consumers, who account for nearly 70% of economic growth, continue to spend, even if they resent having to pay more. Partly, this is due to widespread income gains and partly because many Americans have even more savings than before the pandemic, after postponing spending on vacations, entertainment and restaurants.
When inflation is driven primarily by demand, it may require more drastic action from the Fed than when it is driven primarily by supply shocks, such as a disruption in oil supply, which can often resolve itself.
Economists fear that the only way for the Fed to slow robust consumer demand is to raise interest rates to such a high level as to dramatically increase unemployment. and potentially cause a recession. Generally, with the increase in fear of layoffs, not only the unemployed reduce spending. So too are the many people who fear losing their jobs.
Some economists now think the Fed will need to raise its short-term policy rate much higher, to 4.5% or higher, early next year, more than previous estimates of 4%. (The Fed’s key rate is now between 2.25% and 2.5%.) Higher Fed rates, in turn, would lead to higher costs for mortgages, auto loans and business loans.
The Fed is expected to raise its short-term policy rate by a substantial three-quarter point next week for the third consecutive time. Tuesday’s inflation report even led some analysts to speculate that the central bank may announce a full percentage point hike. If so, it would be the biggest increase since the Fed began using short-term rates in the early 1990s to drive consumer and business lending.
While headline inflation rose slightly last month, core inflation, which reflects broader economic trends, worsened. A measure that the Federal Reserve Bank of Cleveland uses to track median inflation, which essentially ignores the categories with the largest price swings, rose 0.7% in August. This was the largest monthly increase since registrations began in 1983.
Higher prices have yet to cause much of what economists call “demand destruction” – a spending rollback that could quell inflation. Although higher gas prices have caused Americans to drive less, there isn’t much evidence of significant cuts elsewhere.
Restaurant prices, for example, increased by 0.9% in August and by 8% in the last year. But that hasn’t greatly deterred people from going out. Restaurant traffic surpassed pre-pandemic levels on Open Table, an app that tracks reservations, and continued to increase through September.
Overall, consumers largely kept spending, even with rampant inflation, albeit perhaps through gritted teeth. In July, spending increased by 0.2% after correcting higher prices.
The spread of inflation in services, such as rental costs and health care, largely reflects the impact of higher wages. Hospitals and doctors’ offices have to pay more for nurses and other staff. And as more and more Americans find jobs or get raises, they are able to move out of family homes or separate from roommates. Rental costs have risen 6.7% over the past year, the highest since 1986.
Wages and salaries rose 6.7% in August from the previous year, according to the wage monitor of the Federal Reserve Bank of Atlanta, the largest increase in nearly 40 years. And Luzzetti noted that the same data shows a record wage premium for people who change jobs, compared to those who stay. This means that employers are still offering big raises to try and fill jobs.
Economists hoped that rising service prices would be offset by falling costs for new and used goods such as cars, furniture, and clothing after those items increased during the pandemic. As supply chain backups improved, it was expected that a better flow of these goods would bring down prices.
Yet so far it has not happened.
“We have seen shipping costs decrease, supply chain congestion eased somewhat, production has improved and inventory has increased,” said Laura Rosner-Warburton, senior economist at MacroPolicy Perspectives. “So all of this suggests an improvement on the supply side. Yet companies are still experiencing steep price increases for those assets, and this is problematic. “
Such trends could renew the debate on how much the ability of companies to raise prices has been fueled by the lack of competition, a phenomenon called “greedflation”. But most economists attribute the ability of companies to charge even more to the willingness to pay of consumers.
“It appears that retailers are raising prices because they can, not because they have to. Consumer demand is still too strong, ”said Aneta Markowska, chief economist at Jefferies, an investment bank, in a research note.