Declining energy prices keep March consumer inflation in check

Energy prices declined and food was flat in March, the combination of which mostly offset persistent upward pressure in service costs. The result was a fractional 0.1% uptick in the consumer price index (CPI) in March, the smallest single-month advance in consumer prices since a comparable increase in December. Economists had expected inflation pressures to ease, although the consensus forecast had been for a slightly higher 0.2% gain for the month.

More notably, the 12-month change in the CPI declined sharply from 6.0% in February to 5.0% in March, primarily due to the outsized 1.0% gain from March 2022 falling out of the 12-month calculation. The decline in the headline number marked the ninth consecutive month that CPI has slowed from its highest level recorded in decades. It’s a hopeful sign that the worst inflation scare in the United States in generations is increasingly in the rearview mirror.

Despite those promising signs, there’s still some downside in the report.

Core inflation, which strips out volatile food and energy costs, rose by 0.4% in March and has shown little evidence of easing in recent months. The 12-month increase in core CPI edged up to 5.6% in March and has been stuck in a narrow range since late last year.

The most significant component of the core index — shelter costs — rose by 0.6% last month, extending a string of hefty price increases for housing, despite a marked downturn in the single-family housing market since last year. A relative lack of supply and a spike in demand had lifted housing costs across much of the country before the combination of elevated prices and sharply higher mortgage rates took a toll. Rental rates continued to rise though, and the impact of turning points in housing market conditions typically takes more than a year to become apparent in the CPI shelter cost data.

At the margins though, the pace of the monthly increase in shelter costs eased modestly — too soon to conclude that it’s definitively rolled over but enough to provide some hope that it may be in the process of doing so.

However, it’s not just a housing story. Upward pressure in services pricing has extended across other sectors, as tight labor market conditions created a competition for labor that lifted wages across the country since 2020. As a key component to the cost structure for most service-oriented businesses, higher labor costs have been passed along to consumers, particularly as household spending has tipped more toward services and away from goods. Wage gains have eased from their cyclical peaks, but further softening in labor conditions remains a key component to the Fed’s game plan for reducing inflation.

There’s a little something for everyone in the March CPI report — certainly enough fodder for both bulls and the bears to see what they want to see. The question is “what will the Fed see?”

Undoubtedly, the marked decline in headline inflation will be embraced as evidence that central bank efforts to cool the economy and rein in inflation is having an effect. That’s the good news. The more troubling aspect of the report lies in the fact that core prices are proving to be comparatively sticky. Given the oft-noted “long and variable lag” in monetary policy, much of the impact of Fed rate hikes has undoubtedly yet to be absorbed into the economy. Even in the absence of further rate increases, it’s likely that those already implemented will continue to cool activity in the coming months.

The question for policymakers is whether or not the delayed effect of prior policy tightening will be enough to bring inflation back to the Fed’s 2% target or if they believe more tightening is needed.

Coming out of its March meeting, the Fed’s updated projections pointed to the probability of another 0.25% hike before the end of the year. With labor market gauges still relatively tight and core inflation sticky at a level that’s well above the Fed’s inflation target, at least one more rate increase appears to be all but certain barring some sort of shock to the system before the Fed’s early May meeting.

The bottom line? Broadly, the March inflation picture extended the recent trend of gradual disinflation, as the economy moves further past the worst inflation scare in decades. Still, the underlying stickiness of price increases creates a vexing problem for a Fed that’s trying to navigate an increasingly difficult path to a soft landing. Killing inflation without ending the expansion isn’t an easy task, particularly when inflation isn’t going down without a fight.