The key inflation indicator rises 6.8% in June as prices continue to rise

An inflation indicator closely followed by the Federal Reserve jumped 6.8% in June from a year ago, the largest annual increase in four decades.

Government data on Friday underscore the persistence of inflation which is eroding Americans’ purchasing power, undermining their confidence in the economy and threatening Democrats in Congress ahead of November’s midterm elections.

On a monthly basis, prices rose 1% from May to June, faster than the 0.6% increase from April to May and the largest such jump since 2005.

“Consumer sentiment sure stinks, but Americans continue to increase their spending anyway,” said Bill Adams, chief economist at Comerica Bank, in response to inflation data released this morning.

A separate government report on Friday reinforced the fact that the economy remains gripped by inflationary pressures. A measure of private employee wages rose 1.4% in the April-June quarter, equaling a record set last fall. Higher wages can fuel inflation if companies pass their higher labor costs onto their customers, as they usually do.

The Fed closely follows this ratio, known as the labor cost index, and takes it into account in its interest rate decisions. The sharp rise in the index last fall contributed to the Fed’s shift in credit tightening.


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Consumers struggling to keep up

The government also reported Friday that consumer spending managed to outrun inflation last month, rising 0.1% from May to June after adjusting for price changes. Consumer spending, the main driver of the economy, weakened in the face of high inflation. But for now, it’s still helping inflation, with demand still strong for services, ranging from airline tickets and hotel rooms to restaurant meals and cars.

“Even in the face of extraordinary inflation, consumers were confident enough to increase spending in June,”
Jeffrey Roach, chief economist at LPL Financial, said in an email, adding that many could log into their savings account to do so.

“A sore point is on the income side. Personal income growth in June was out of step with inflation, so consumers drew on savings and credit to offset the historic price increase,” Roach said. .

Inflation has risen so fast that, despite the wage increases received by many workers, most consumers lag behind the pace of expenses for the cost of living.

During the onset of the COVID-19 pandemic, Americans’ monetary funds grew as they hunkered down, took shelter in place, and stopped spending money on dining out, traveling, and more. They also benefited from three rounds of stimulus checks, extra unemployment aid and child tax credit payments.

Roach believes consumers have accumulated enough to get them through the year. “The high stock of savings is expected to last into this year as consumers use it to offset persistent price pressures,” he said.


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Buyers have squeezed

Many retail and consumer goods chains say inflation is squeezing shoppers and limiting how far their money goes, a sign that consumer spending could weaken further.

Walmart this week said it is profits would fall because its customers spend more on more expensive food and gas, leaving them less able to buy clothes and other discretionary items. Likewise, Best Buy downgraded its sales and profit forecasts because rising inflation forced consumers to cut back on their home appliance purchases.

Procter & Gamble, which makes Tide and Pampers detergents, among many other essentials, said its customers are also holding back their purchases after spending heavier in the spring.

High inflation and interest rates are also hindering the US economy, which it shrank in the April-June quarter for the second consecutive quarter, intensifying fears that the US is in recession. However, two quarters of declining growth satisfy an informal rule of thumb for when a recession begins robust intake suggests that the economy still holds pockets of strength and is not yet in a downward phase.

“Consumers drove less in June in the face of rising gasoline prices and went down to the supermarket due to rising food prices,” said Adams of Comerica Bank.


The Fed raises interest rates again amid recession fears

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Wednesday the The Fed raised its benchmark three-quarter point interest rate for the second consecutive time, in its most aggressive push in more than three decades to tame high inflation. Powell warned that the pace of Fed rate hikes could slow down in the coming months.

However, Powell stressed that Fed policymakers consider fighting inflation their top priority. He gave no hint that a weakening economy would cause the Fed to slow or reverse its rate hikes this year or early next year if inflation remained high.

By raising lending rates, the Fed makes it through more expensive to take out a mortgage or a car or business loan. The goal is for consumers and businesses to borrow, spend and hire less, thereby cooling the economy and slowing inflation.

During the April-June quarter, US consumers increased their spending, even after correcting for inflation. But the figure amounted to a paltry 1% annual gain, down from 1.8% in the January-March period.

“As long as households continue to buy, the economy should avoid a recession,” said Gus Faucher, chief economist of the PNC in a research note.

On Thursday, President Joe Biden dismissed the notion that a recession had begun. Biden pointed to still solid employment growth, an unemployment rate near a half-century low, and a spate of investment by semiconductor companies as evidence that the economy is still healthy.

Biden also welcomed a deal forged by the Senate Democrats on a stripped-down version of his Build Back Better legislation, which many economists believe could slow inflation over time. The bill would cut the government’s budget deficit, which curbs inflation by reducing overall demand. It would also reduce spending on seniors by allowing Medicare to negotiate the prices of certain drugs.

The Fed tends to monitor Friday’s indicator, called the Personal Consumer Spending Price Index, even more closely the government’s best-known consumer price index. Earlier this month, CPI reported an acceleration in inflation, up to 9.1% in June compared to the previous yearthe highest reading of this type in 41 years.

The PCE index, which tends to show a level of inflation below the CPI, is a broader measure of inflation that includes payments made on behalf of consumers, including medical services covered by government insurance or programs. The CPI only covers out-of-pocket expenses, which have increased the most in recent years. Rents, which are increasing at the fastest pace in 35 years, also carry less weight in the PCE than in the CPI.

The PCE price index also tries to account for changes in how people shop when inflation rises. As a result, it can catch, for example, when consumers switch from expensive domestic brands to cheaper store brands.

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