The pace of inflation is easing as many of the supply-induced pressures have faded and consumer demand and spending habits have shifted. Energy prices are also lower than a year ago. This is good news for many aspects of the inflation outlook.
The problem is the stickier parts of inflation. The US consumer price index rose 6 per cent year on year in February while core inflation – which excludes energy and food prices – rose 5.5 per cent over the same period. Those were both lower than in January and their respective peaks of 9 per cent and 6.6 per cent in 2022.
Still, these figures remain some way from the Fed’s 2 per cent inflation target, and achieving that this year will be difficult. So, while inflation is not falling as quickly as the Fed and other central bankers might hope, it is coming down. This trend is likely to continue through to the middle of the year.
Beyond that, however, inflation could linger at a rate higher than the Fed wants, mainly because the shelter component will only gradually capture the slowdown in housing and rental markets.
More recently, the aggressive rate rises have started to take their toll in pockets of the US banking sector. The actions of the Fed, Treasury Department and the Federal Deposit Insurance Corporation to provide stability and backstop depositors could be at odds with the continuation of this rate-raising cycle.
As inflation continues to fall, the Fed will be faced with a trade-off between growth and inflation once more, with the added complexity of financial market security. The central bank may be willing to tolerate higher inflation given the tough stance and rhetoric on returning the economy to a 2 per cent rate.
Some reasons inflation could be higher are beyond the control of the Fed and other central bankers. Globalisation has been a powerful force in reducing the price of goods and labour around the world, but this has started to slow.
Rising income inequality is another reason inflation was low. Wealthier households tend to spend less as a share of their total income. Government regulations to address income inequality could ease this downward force on inflation.
The shift towards net zero greenhouse gas emissions will also come at a cost, and this is likely to have some effect on inflation. This list is not exhaustive but includes forces that could shift from being a hindrance to a help when it comes to rising prices.
Furthermore, if the Fed is willing to let inflation settle somewhere near its 2 per cent target, this reduces the chance of having to deal with a period of below-target inflation and having to return to zero interest rate policies or quantitative easing to the same extent.
For now, inflation is still too high for the Fed’s liking. If markets regain some semblance of composure before the March 21-22 meeting, the Fed is likely to raise interest rates by another 25 basis points.
Kerry Craig is a global market strategist at JP Morgan Asset Management