Chief Economist, INVEX, Mexico
Drawbacks of Sticky Inflation
The U.S. Federal Reserve Bank (FED) has set an inflation target -measured through the annual percentage change of the core personal consumption expenditures price index (PCE)- of approximately 2.0%1. Although this measure of inflation has dropped significantly from a maximum annual rate of 5.6% reported for February 2022, it faces downward resistance (2.9% in December 2023) and remains significantly above the central bank's target.
Some alternative price measures present a somewhat more pessimistic picture. According to the Atlanta FED, annual inflation measured through the Sticky Consumer Price Index (Sticky CPI) is about 4.6%. Another calculation referred to as the Supercore CPI registers a 3.9% annual growth rate.
Some components of U.S. price indices have not completely subsided, mainly those of shelter and transportation prices which still register significant monthly advances. In fact, U.S. core inflation would not have descended as it has until now if it were not for the declines in used car prices in recent months. The prices of these goods increased significantly due to the distortions in the global supply chain that occurred during the COVID-19 pandemic, as well as a strong increase in demand due to the low availability of new cars. Now these prices have fallen, and they might fall even more.
Inflation (particularly core inflation) is sticky. Sticky inflation generates drawbacks. The main drawbacks of sticky inflation are related to a deterioration in market inflation expectations. The fact that annual core inflation does not consolidate below 3.0% could affect analysts' forecasts beyond the short term. This in turn could reduce the FED’s margin to begin a monetary easing cycle soon. Moreover, if inflation does not confirm a downward trajectory towards the 2.0% target in the following months, even the central bank’s credibility would be compromised, which in turn could generate more damaging effects on inflation expectations.
If inflationary expectations do not abate, processes such as price formation and wage determination could be contaminated, with negative impacts on the purchasing power of families and the economy as a whole.
To all this, one must add that inflationary risks in the U.S. are skewed to the upside because of a better-than-expected economic growth. As long as employment expands at a stable stance, higher private consumption expenditures are likely to exercise additional pressure on inflation and complicate its convergence towards the FED's 2.0% target.
A few weeks ago, the market expected the first FED’s rate cut in March after two years of monetary tightening. As soon as positive economic data was released (particularly labor market indicators), analysts shifted their expectations to a first cut in May. FED members have stressed that a premature reversal of monetary policy could have extremely negative effects on the economy.
Given the persistence of high core inflation and the downward resistance that it has shown, the first 25 BP cut in the FED’s rate could happen in July. Year-end headline and core annual inflation could oscillate around 3.0%. The 2.0% objective would be reached until 2026, and I am not saying that. FED members said it in their most recent summary of economic projections.
Ricardo Aguilar-Abe is Chief Economist at INVEX. All the affirmations contained in this article solely reflect the author’s point of view. Any comments related to this publication can be sent to the following address: analisis@invex.com.
Footnotes:
In the United States, core inflation is defined as headline inflation less food and energy inflation.
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