With the announcement on Tuesday that consumer price inflation had been higher than expected in August, the recent streak of positive economic news for Joe Biden and the Democrats came to an end. The headline inflation rate fell from 8.5% in July to 8.3% last month, according to the latest report from the Labor Department, but the base rate, which excludes volatility in energy prices and food, rose from 5.9% to 6.3% as the cost of rent, new cars and other items rose in what the report called a “general” increase. Economists and the Federal Reserve are watching the base rate closely, as they believe it paints an accurate picture of underlying trends. The central question now is whether Fed Chairman Jerome Powell and his colleagues will raise interest rates more aggressively to temper inflation, a move that could inadvertently tip the economy into a recession. .
The inflation report caused a sell-off on Wall Street: stocks suffered their biggest drop in more than two years. However, amid renewed criticism of the Biden administration from Republican leaders, the Consumer Price Index (CPI) report needs to be put into perspective. Despite some worrying features, he confirmed that overall inflationary pressures are easing gradually, but not as quickly as many consumers would like. In June, the overall rate was 9.1%, so in two months it fell by 0.8 percentage points. And, even though the base rate has risen, there is reason to believe that it will come down significantly over the next few months. “Overview, the CPI base rate continues to slowly decline,” Ian Shepherdson, chief economist at Pantheon Macroeconomics, told me. “I have no doubt that will drop significantly over the next six months.”
As Biden was quick to point out, gasoline prices fell sharply over the summer. How prices move from here depends on what happens in the global oil market, which is hard to predict. But the price of crude oil fell again on Tuesday, and if that continues, prices at the pump will continue to fall. Until what point? “Except hurricanes or unexpected breakdowns. . . the national average could drop to $3.49, then $3.25,” Patrick De Haan, an oil analyst at GasBuddy, a tech company that helps people find cheap gas, told Yahoo Finance. “And it’s not impossible that we’re on track for a national average of $2.99 by the end of the year.”
Cheaper gasoline is good news for motorists, obviously, but it’s also good news for anyone shopping for food, which is pretty much everyone. Over the past twelve months, according to the August report, the cost of food eaten at home or away from home has increased by 11.4%, the largest annual increase since May 1979. One of the things that has propelled food prices upward was sharply higher transportation costs. With lower fuel prices, these costs are now falling, which should eventually lead to lower food prices. If not, someone somewhere is taking advantage of it. The same goes for airfares, which fell 4.6% last month. The cost of kerosene having fallen sharply during the summer, the prices for the fall should fall further significantly.
Then there is the global supply chain crisis, which is finally starting to ease. This is particularly evident in the automotive industry. The past two years have seen a severe shortage of new vehicles, which has led to a dramatic increase in used car prices. More recently, however, used car auction prices fell 4% in August alone, according to an industry index. So far, these lower auction prices have not resulted in a sharp drop in the prices car dealerships charge for used vehicles. It should happen soon. And as used cars become considerably cheaper, this should limit dealers’ ability to raise new car prices. With vehicles accounting for around 11% of the CPI, these developments are far from trivial.
Another factor to consider is the role that rents, which account for almost a third of the CPI, i.e. a large part of it, play in keeping inflation high. Over the last twelve months, according to the August report, rents for primary residences have increased by 6.7%. (This figure includes rent paid by people with longer-term leases, so it takes into account the much larger increases for new leases seen in some places, such as parts of New York.)
The rise in rents reflects multiple factors, including strong demand, a shortage of available rentals and soaring property prices, which have shut out some potential buyers and turned them into tenants. While the Fed has recently raised the federal funds rate, mortgage rates have also risen sharply. As a result, home sales have slowed and prices are now falling in many parts of the country. If they continue to fall, and they probably will, buying will become a more attractive option, reducing rental demand. This, in turn, should put downward pressure on rents. Unfortunately, this could take some time. “While we expect housing cost pressures to ease in the coming months due to a sharp decline in housing demand, the price slowdown will not be evident for a few months,” Gregory Daco, chief economist at EY-Parthenon, wrote in a commentary on the inflation report.
Based on these and other factors, including a squeeze on profit margins as pandemic-related supply restrictions continue to ease, Shepherdson forecasts that by March next year, the rate core inflation will have fallen from 6.3 to 4.8%. He also cited Wednesday’s release of the Producer Price Index for August, a separate report, which showed wholesale prices fell slightly in the month and rose 8.7% on an annual basis, the smallest increase in a year. “It unambiguously showed that inflation was falling in both the goods and services sectors,” he noted.
In their eagerness to shift the focus from Donald Trump’s midterm elections and abortion rights to inflation and the cost of living, Republicans are skating on any encouraging economic developments, of course. The danger is that with only one monthly inflation report remaining before election day – it will be released on October 13 – their message could resonate. Although Biden’s approval ratings have rebounded somewhat in recent weeks, a new Harvard CAPS-Harris Poll indicates that fifty-four percent of Americans still believe their personal finances are deteriorating. (Forty-six percent of respondents said their situation was improving or not changing.)
With prices always rising faster than wages, these poll results are not surprising. But with the headline inflation rate falling, and with wage pressures and inflation expectations contained, there are still reasons to be optimistic and there is no reason for the Fed to panic. When Powell and his colleagues meet next week, the Fed chief should make that clear and resist calls for more drastic interest rate hikes. Bringing inflation down will take time, but the process is already underway.