The bottom line? Inflation is hotter than expected
- Inflation is still hanging around like an unwelcome relative at Thanksgiving dinner; it may not be completely unbearable, but it’s certainly more than a little irritating. What’s worse, they may now be looking for a second helping.
- The unexpected acceleration in inflation marks the third consecutive monthly uptick in the consumer price index and extends a reflationary trend since two consecutive flat months for the index in May and June 2024.
- Economic growth has been firm, with consumers spending briskly into the end of last year. Labor conditions have shown signs of stabilizing, with job creation in recent months solidifying and the unemployment rate still quite low.
- Against a backdrop of solid demand, inflation has accelerated. It’s a reality that may spook consumers who remember the effects of the COVID-19-era price spike. It will also make President Trump’s proposed import tariffs a tougher sell than was the case during his first term, when both inflation and interest rates were exceptionally low.
By the numbers: All the key price measures topped forecasts
- The consumer price index surged unexpectedly in January, rising by 0.5%, well above consensus expectations of 0.3%.
- A 1.1% increase in energy costs certainly played a role, but the surge can’t solely be laid at the feet of oil prices.
- Core inflation, which excludes more volatile food and energy prices, rose by 0.4% for the month, also topping the 0.3% forecast.
- The result: 12-month trailing measures of inflation both accelerated, with headline prices rising by 3.0% and core increasing by 3.3%.
- Shelter costs remain a major challenge to bringing inflation back to a more benign environment. Representing more than a third of the index, shelter costs rose by 4.4% over the past year. Without meaningful progress in slowing housing price increases, reaching the Fed’s 2% inflation target will be a tall order.
Broad thoughts: Near-term inflation expectations are murky
- A potential resurgence in inflation has commanded more of the Fed’s policy focus as labor conditions firmed in recent months. That’s allowed the Fed to turn its attention back toward the potential that elevated inflation remains sticky or even reaccelerates. Solid growth had been a key underlying factor, as consumption has remained robust despite Fed attempts to cool conditions in recent years.
- Exacerbating the inflation outlook is the expectation that current and expected tariffs will raise prices for a range of imports, hitting businesses and consumers alike. How significant the impact will be remains a question.
- What will actually be imposed is a moving target, creating considerable uncertainty for economists and policymakers alike.
- The murkiness of evolving trade policy creates a significant unknown for Fed policymakers who will have to grapple with the potential conflicting policy challenges of slower real growth and higher inflation. While even bearish forecasts are a far cry from the stagflationary environment of the 1970s, the playbook would seemingly still apply. Arresting inflation is likely to remain the priority for the Fed, even at the expense of near-term growth. The potential for inflation expectations becoming unanchored is just too much for policymakers to ignore.
- For now, it’s a “wait-and-see” approach for Fed chair Jay Powell and his colleagues, who recognize that the case for further easing in the near term has been reduced. Rate hikes don’t appear to be on the table, but a sustained resurgence in inflation could change that.
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