Inflation relief?
Recent U.S. data shows that inflation is finally decelerating and only rose 4% in May verses a year earlier. That was a step down from April’s 4.9% increase and marks the smallest monthly increase in more than two years. Last June, inflation peaked at 9.1%. Inflation has been a global phenomenon as a result of extreme dovish monetary policy during the pandemic. With trillion of dollars flowing into the economic system, prices started to increase across the board. The federal reserve bank and other central banks globally have been trying to slow the economy by increasing interest rates, but it has been a slow and difficult journey.
Finally, it seems that there are slower price hikes. At 4% in the U.S., this is significantly lower than in Europe, and will likely lead to a rate divergence when the cycle is turning, and central banks will start cutting rates again. This will likely happen in 2024 and it appears that the U.S. will be in a far better position for rate decreases compared to Europe.
The latest consumer price index data from May finally provides some breathing room for the federal reserve after hiking interest rates in 10 consecutive moves since early 2022 to try to slow the economy. The Fed will meet later this week and it is expected that they will opt for a long-anticipated pause in hikes even though the inflation rate is still higher than the target of 2%.
Looking more closely at the recent data, the core consumer price index, which excludes volatile food and energy prices, actually rose a concerning 0.4% from a month ago and 5.3% year-over-year. Rising housing costs were the largest contributor to last month’s increase, followed by used cars and trucks. Among other prices that rose were transportation services, apparel, personal care and education. On top of that, food prices also increased with an uptick of 0.2%. The food index rose 6.7% over the last 12 months. The energy index, meanwhile, fell 11.7% over the last year. So basically, the only good news and the reason for the 4% inflation is the fact that energy prices are significantly lower. Otherwise, the news is not so good.
The rate is also still above the target rate of 2%. The continued rise in prices comes the same month the job market added a surprisingly high number of jobs, 339,000. As the benchmark federal funds rate is 5.25%, the Fed had hinted it was done hiking interest rates after raising them to the highest level in 16 years. Although the Fed might take a hike pause in the June meeting, the job is clearly not done.
Politicians are boosting that the inflation crisis is over and that all is going well with the inflation down to 4%. In reality though, this is a result of the drop in energy prices. Otherwise, prices are still increasing. Consequently, the Fed will have to increase the interest rate again in order to slow inflation and ultimately reach the 2% target rate. So more to be done by the Fed and unfortunately this means even higher interest rates before the high inflation is defeated. Despite this, a hike pause in the June meeting is still likely, but there will be required hikes in future Fed meetings.