Could inflation ease more swiftly than the Federal Reserve expects?
Consumer price increases have pulled back sharply in recent months but Fed Chair Jerome Powell says further declines to the Fed’s 2% annual target may prove a tougher slog.
As a result, he says, the Fed may need to raise its key interest rate even higher than the 5% to 5.25% peak officials have forecast, an aggressive strategy that many economists say will trigger a recession.
“We will need substantially more evidence to be confident inflation is on a sustained downward path,” Powell said after raising its benchmark rate by a quarter point to a 4.5% to 4.75% range earlier this month. It capped the most aggressive flurry of rate increases – 4.5 percentage points – since the early 1980s.
Some top economists, however, say inflation is poised to tumble more rapidly than Fed officials expect in coming months, a scenario that could limit further rate hikes and help avoid a downturn.
Their sanguine outlook hinges on two developments:
►Rent, which makes up 40% of inflation that excludes food and energy, could slide more briskly than Fed officials believe over the next few months.
►Wage growth in service industries like health care, education, and white-collar professions doesn’t appear to be driving up prices as much as Powell fears.
Inflation eased to 6.5% in December from 7.1% in November and a 40-year high of 9.1% in June, according to the Consumer Price Index (CPI). Barclays predicts the Labor Department on Tuesday will report a further drop to 6.2% in January.
What it takes to buy a house: What is a good income to buy a house? You’ll need at least $100,000 in nearly 40% of markets
Tax guide: IRS free file options: Your 2023 guide to free tax prep service
Powell has noted that much of the decline can be traced to falling prices for goods such as used cars, furniture and appliances as pandemic-related supply chain troubles have been resolved.
How much have rents increased?
Rent, meanwhile, was a big culprit in the inflation run-up as COVID led people to move into their own apartments. But it’s showing signs of slowing, Powell says. Rent for new leases fell for four straight months on a monthly basis before flatlining in January, according to RealPage, a real estate research and property management software company.
RealPage chief economist Jay Parsons mostly points to a large supply of new apartment buildings that are moderating price gains along with weaker renter demand tied to a softening economy. Apartment occupancy was at 94.8% last month, down from 97.5% a year earlier, RealPage figures show.
Yet rent was up 8.3% annually in December, the most since 1982, according to the CPI. Powell has noted it could take until much later this year before the drop in rent for new leases significantly affects lease renewals for existing tenants and brings down overall rents.
“Housing inflation tends to lag other prices around inflation turning points…because of the slow rate at which the stock of rental leases turns over,” Powell said in a speech in late November.
Parsons disagrees. While new tenants generally pay more in rent than existing ones, the gap between those groups has been steadily shrinking, from 10.1% in June to 3.3% in January, RealPage data shows. That’s a perilous situation for landlords, Parsons says because existing renters who don’t think they’re getting a better deal than new arrivals will bolt.
As a result, he thinks rent increases for lease renewals will decline quickly. Already, he says, the average annual rise has dropped to 8% from 11% last summer and he expects a retreat to low single-digit price gains by mid-2023. He projects rent inflation broadly will drop to 3% this year from 14.6% in 2021 and 5.7% last year.
“It’s changing very fast,” Parsons says.
Is inflation caused by rising wages?
Powell’s biggest concern is inflation for services, excluding housing, such as health care and education. It makes up 56% of underlying inflation excluding food and energy and hasn’t budged noticeably, Powell says. Most of those price increases, he says, are driven by rising wages.
The Fed, in turn, must slow wage increases by raising interest rates to dampen employer demand for workers and reduce job growth.
Last week, after the January employment revealed a booming 517,000 job gains, Powell said, ““I think it underscores the message … that we have a significant road ahead to get inflation down to 2%.”
But a Morgan Stanley analysis shows the biggest part of such services inflation over the past two years was in transportation, especially airfares. Airfares, however, increased sharply starting in mid-2021 not because of climbing wages but because of COVID-related fuel price surges and a burst of pent-up consumer demand for travel, says Seth Carpenter, Morgan Stanley’s chief global economist wrote in a research note.
Now, fuel prices have dropped and travel demand is steadier. Airfares fell on a monthly basis in six of the last seven months of 2022, CPI figures show. And while they were still up 28.5% annually in December, the monthly declines should soon bring down the yearly increase, Carpenter says.
The bottom line?
“Wage inflation wasn’t really what was driving the surge in inflation,” Carpenter says. “Our view is it’s not as big a deal as you may think.”
Carpenter expects the Fed’s preferred inflation measure – which is different than the CPI – to fall to 2.9% by the end of the year, below the Fed’s 3.1% forecast.
This article originally appeared on USA TODAY: Inflation rate could slow faster than Fed believes, minimizing hikes
Source: https://finance.yahoo.com/news/inflation-could-ease-faster-fed-100100808.html