Driven by consumers, US inflation grows more persistent

The Federal Reserve may need to take extreme steps in order to stop the U.S. inflation from entering a more stubborn phase, which has alarmed financial markets and increased the likelihood of a recession.

Some of the traditional causes of greater inflation, such as rising gas costs, supply chain bottlenecks, and skyrocketing used vehicle prices, are starting to fade. However, fundamental indicators of inflation are really becoming worse.

The causes driving an inflation rate that is close to a four-decade high are still evolving, making it more difficult for the Fed to keep it under control. Due to the cost increases in a few categories, prices are no longer growing. Instead, because of a robust job market that is increasing wages, pressuring businesses to increase prices to match rising labor costs, and providing more consumers with disposable income, inflation has now become more pervasive across the economy.

The government said on Tuesday that inflation increased 0.1% from July to August and 8.3% from a year earlier, which was lower than the four-decade high of 9.1% in June.

However, following a softer 0.3% increase in July, so-called core prices—which exclude the erratic categories of food and energy—rose by an unexpectedly high 0.6% in August. The Fed keeps a close eye on core prices, and the most recent statistics increased concerns about a more assertive Fed and sent equities tumbling, with the Dow Jones down more than 1,200 points.

The core pricing data confirmed concerns that inflation has now reached every sector of the economy.

The broad-basedness of the price rises is “one of the most striking things,” according to Matthew Luzzetti, chief U.S. economist at Deutsche Bank. “The underlying inflation trend has undoubtedly not made any headway toward slowing so far. The Fed should be concerned about this because price increases are now more likely to be sustained since demand is driving them.

One approach to describe demand-driven inflation is that it occurs as a result of consumers’ continued spending, which accounts for close to 70% of economic growth. That is due in part to general salary increases and in part to the fact that many Americans still have more money than they had before to the epidemic after delaying purchases of travel, entertainment, and dining.

Demand-driven inflation may need more forceful action from the Fed than supply-driven inflation, such as that caused by disruptions in the oil supply, which often go away on their own.

Economists worry that the Fed will only be able to moderate strong consumer demand by substantially raising interest rates, which may perhaps trigger a recession. Usually, when the likelihood of layoffs increases, fewer people become unemployed and spend less. The many folks who worry about losing their employment feel the same way.

Some analysts now believe the Fed will need to increase its benchmark short-term rate considerably more than initial projections of 4%, to 4.5% or more, by the beginning of next year. Greater rates from the Fed would, in turn, result in higher prices for mortgages, car loans, and business loans (the Fed’s main rate is now in a range of 2.25% to 2.5%).

The Fed is anticipated to increase its benchmark short-term rate by a significant three-quarters of a point for the third time in a row next week. Even some experts speculated that the central bank may declare a full percentage point increase in response to Tuesday’s inflation data. If so, it would be the biggest rise since the Fed started using short-term rates to control consumer and corporate borrowing in the early 1990s.

The underlying inflation rate, which reflects wider economic patterns, deteriorated even though headline inflation barely increased last month. An indicator of median inflation used by the Federal Reserve Bank of Cleveland, which effectively overlooks markets with the largest price volatility, increased 0.7% in August. Since data have been kept since 1983, it was the largest monthly rise.

Few instances of what economists refer to as “demand destruction”—a reduction in spending that may lower inflation—have been seen as a result of higher prices. Although Americans drive fewer miles now because of rising petrol costs, there isn’t much evidence that other countries have made comparable reductions.

For instance, the cost of dining out increased by 0.9% in August and by 8% over the previous 12 months. But it doesn’t seem like that has stopped folks from coming out. On Open Table, an app that records bookings, restaurant traffic has exceeded pre-pandemic levels and continued to rise into September.

Even with high inflation, customers have mostly maintained their spending, if maybe through clinched teeth. Spending increased 0.2% in July after accounting for rising costs.

The effect of rising salaries is mostly seen in the expansion of inflation into services, such as rental expenses and health care. Nurses and other employees cost more at hospitals and doctor’s offices. Additionally, more Americans are able to leave their parents’ houses or break up with their housemates when they get jobs or increases. The most since 1986, rental prices have climbed 6.7% in the last year.

According to the Federal Reserve Bank of Atlanta’s pay tracker, wages and salaries increased 6.7% in August from a year earlier, the largest gain in over 40 years. And Luzzetti pointed out that the same data indicates a record salary premium for job changers compared to those who remain in their current positions. Therefore, firms are still attempting to fill positions by giving large increases.

After these things’ prices soared during the epidemic, economists had thought that lowering prices for goods like new and used automobiles, furniture, and apparel would balance out rising service prices. Prices were anticipated to decrease if supply chain backups improved and a better flow of these commodities occurred.

However, it hasn’t occurred so far.

According to Laura Rosner-Warburton, senior economist at MacroPolicy Perspectives, “we’ve seen shipping prices come down, we’ve seen supply chain congestion alleviate a little bit, output has increased and stocks have grown.” “All of it thus points to a potential supply side improvement. However, businesses are still raising their prices significantly for such products, which is problematic.

However, most economists credit the ability of firms to continue charge more to customers’ desire to pay. Such developments might reignite the argument over how much corporations’ capacity to increase prices has been fuelled by a lack of competition, a phenomenon known as “greedflation.”

Retailers now seem to be increasing prices because they can rather than because they have to. The consumer demand is still too high, according to Aneta Markowska, head economist at the investment firm Jefferies.

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