When inflation started accelerating in 2021, price pressures were pandemic-related: companies couldn’t produce cars, sofas and video games fast enough to meet consumer demand confined to their homes, due to supply chain disruptions.
Posted at 7:00 a.m.
This year, the war in Ukraine has caused fuel and food prices to soar, exacerbating price pressures.
Now, with these sources of inflation showing early signs of weakening, the question is how much the overall price increase will subside. The answer will likely depend in part on what happens in one crucial area: the labor market.
Curb momentum
Federal Reserve officials are focused on job creation and wage growth as they rapidly raise interest rates to rein in the economy and slow rapidly rising prices. Officials are convinced that they must rob the economy of some of its momentum to bring inflation, the worst in four decades, back to their target of 2%.
They do this by slowing spending, hiring, and salary increases, and by increasing borrowing costs. So far, a sharp slowdown has proven elusive, suggesting to economists and investors that the central bank may need to be even more aggressive in its efforts to moderate growth and lower inflation.
As this week’s data has shown, prices continue to soar. And, although the job market has slowed somewhat, employers continue to hire at a brisk pace and raise wages at the fastest rate in decades. This continued progress appears to allow consumers to continue spending and could give employers the power and incentive to raise prices to cover their rising labor costs.
An inevitable recession?
Economists say as inflationary forces accelerate, the risk that the Fed will rein in the economy so hard that the United States will face a hard landing increases, which could translate into a drop in growth and a rise in unemployment.
It is increasingly likely “that it will not be possible to squeeze inflation out of this economy without a real recession and rising unemployment,” said Krishna Guha, who leads the global policy team. and central bank strategy at Evercore ISI and predicted that the Fed could slow inflation without causing a recession.
The challenge for the Fed is that, increasingly, price increases seem to be driven by long-lasting factors related to the underlying economy, and less by one-time factors caused by the pandemic or the war in Ukraine.
The August Consumer Price Index data released on Tuesday illustrates this point. Gasoline prices fell sharply last month, which many economists believe should lower headline inflation. They also believed that recent supply chain improvements would moderate increases in commodity prices. The cost of used cars, which was a major contributor to inflation last year, is now falling.
“A very dynamic labor market”
Despite these positive developments, rapidly rising costs for a wide range of products and services helped push up prices on a monthly basis. Rent, furniture, dining out and visits to the dentist are all getting more and more expensive. Inflation increased by 8.3% on an annual basis and by 0.1% compared to the previous month.
The data underscores that, even in the absence of extraordinary disruptions, the price of so many products and services is rising now that costs could continue to rise. Core inflation, which excludes food and fuel costs to give an idea of underlying price trends, accelerated to 6.3% in August after falling to 5.9% in July.
“Inflation currently has a very large underlying component that is driven by a very buoyant labor market,” said Jason Furman, an economist at Harvard University. “And then in any given month you can have more or less inflation just because of the change in the price of gasoline. »
He estimated that core inflation would continue to climb to around 4.5% and rise even if pandemic and war-related disruptions stop pushing prices higher.
War-induced inflation and supply chain disruptions are not entirely behind the US — fighting in Ukraine continues and a railroad strike that threatened to disrupt critical US transit lines was narrowly averted Thursday thanks to a tentative agreement. But encouraging signs show that these two phenomena are beginning to dissipate.
Supply chains began to unravel and prices for oil and some grains fell after soaring during Russia’s invasion of Ukraine.
This could pave the way for a steady slowdown in consumer price inflation, which would help determine how far and how fast inflation can come down. The answers to these questions will depend more on the fundamentals.
Rebalancing supply and demand
“The most important question for the Fed is not: has inflation peaked? It is: what is the destination? said Aneta Markowska, chief financial economist at Jefferies. She believes it will be difficult to get inflation below 4% — double the Fed’s average target of 2% — without a substantial slowdown in the economy and labor market.
“You still have housing and the labor market, and there’s still a lot of inflationary pressure coming from those two areas, which are very unbalanced,” Ms.me Markowska.
This is why the Fed, which meets next week, is trying to rebalance supply and demand.
Central bankers raised interest rates from near zero in March to a range of 2.25% to 2.5% at their last meeting, and it is widely expected that that they be raised by at least a further three-quarters of a basis point next week. The Fed’s actions constitute its fastest rate hike campaign since the 1980s. The goal is to make borrowing more expensive, which in theory will slow consumer spending, allowing supply to rise. catching up and encouraging companies to lower their prices to attract customers.
In the wake of worrying inflation data released on Tuesday, investors began to speculate that the authorities could make an even more drastic rate hike next week, or that they could push rates higher than expected. they would have done so in an effort to rein in the economy.
But if the Fed decides it needs to constrain the economy more intensely in the coming months to meet its targets, as investors increasingly speculate, that could come at a cost.
Central bankers have hoped to slow the economy enough to reduce job vacancies without damaging it to the point of driving up unemployment. Some economists still think it’s possible, given the current unusual labor market situation.
However, a faster and more drastic series of rate hikes would increase the risk of a sharp slowdown in growth that would drive up unemployment.
This article was originally published in The New York Times.