Inflation Causes and Trends

Most Americans consider persistently high inflation and the resulting higher cost of living their number one financial problem. With good reason: top-line inflation is running no less than 3.5%, well above the Fed’s 2% target. And inflation has been well above target for five years running. The table breaks down last year's inflation and this year's expected inflation into their underlying factors. Netting out the inflation tailwinds & headwinds, it’s clear the uncomfortably high inflation is the result of policy choices. Higher broad-based tariffs, a policy choice, added almost 0.5 percentage point to inflation last year and will add another 0.2 this year. Highly restrictive immigration, a policy choice, is steadily adding to inflation as the workforce in construction, agriculture, and other industries is diminished. The Iran war and the surge in energy prices will add another 0.7 point this year. Without these policy-related pressures, inflation would have been 2.2% last year and a bit above 2% this year – effectively at the Fed’s target. Unlike the pandemic or Russia’s invasion of Ukraine, the forces lifting inflation today are largely tied to policy decisions – on trade, immigration, and foreign affairs. These policies may have objectives beyond inflation, but their costs are showing up in higher consumer prices, from groceries and electronics to the cost of filling the tank. At the same time, the decomposition shows that disinflation is already at work. A soft job market and moderating labor costs, rising vacancy rates and falling rents on new leases, and weak vehicle prices are all leaning against inflation. If the policies end, inflation will recede with them. High #inflation is a policy choice. So too, it turns out, is low and stable inflation.

What does today’s CPI indicator publication tell us about inflation? 👉 The monthly Consumer Price Index (CPI) indicator rose 2.3 per cent in the 12 months to November 2024, up from a 2.1 per cent rise in the 12 months to October, according to the latest data from the Australian Bureau of Statistics. The largest contributors to the annual movement were Food and non-alcoholic beverages (+2.9 per cent), Alcohol and tobacco (+6.7 per cent), and Recreation and culture (+3.2 per cent). Partly offsetting the rise in the CPI were annual falls for Electricity (-21.5 per cent) and Automotive fuel (-10.2 per cent). 👉 Annual trimmed mean inflation was 3.2 per cent in November, down from 3.5 per cent in October. This measure remained higher than CPI inflation as it removed large price falls for electricity and automotive fuel. 👉 The CPI excluding volatile items and holiday travel rose 2.8 per cent in the 12 months to November, compared to 2.4 per cent in the 12 months to October, primarily due to changes in electricity prices. The Housing group rose 1.2 per cent in the 12 months to November, up from a 0.2 per cent annual rise to October. Most of this change in the Housing group was caused by the timing of payments of electricity rebates. Electricity rebates lower the price of electricity for households. The impact of the rebates was lower in November than October due to the timing of payments. Most quarterly electricity bills received in November included only one instalment of the Commonwealth Energy Bill Relief Fund, whereas many bills received in October included two instalments. As a result, electricity prices rose 22.4 per cent in the month of November. Compared to 12 months ago, electricity prices were 21.5 per cent lower in November, compared to a 35.6 per cent annual fall to October. Excluding all Commonwealth and State government rebates, Electricity would have fallen 1.7 per cent in the 12 months to November. Rents rose 6.6 per cent in the 12 months to November, following a similar annual rise of 6.7 per cent in October, reflecting continued tight rental markets across the country. New dwelling price rises slowed to 2.8 per cent in the 12 months to November, following a 4.2 per cent rise in the 12 months to October. Annual new dwellings inflation is now the lowest since July 2021, mainly due to builders offering discounts and promotional offers to entice business. Automotive fuel prices fell 10.2 per cent in the 12 months to November, following an annual fall of 11.5 per cent in October. Fuel prices have fallen over the past year as lower global demand has pushed down the price of oil. In monthly terms, fuel prices rose 0.9 per cent in November, which was the first increase in prices since June 2024. Food and non-alcoholic beverages prices rose 2.9 per cent in the 12 months to November, less than the 3.3 per cent annual rise to October. Annual inflation for Food and non-alcoholic beverages is the lowest since January 2022.

A new study published today shows: weather extremes driven by climate change are pushing short-term food price surges globally. Previous studies have linked climate change to long-term food price inflation, while this study shows how climate extremes impact short-term price increases for specific food goods. The study, co-authored by scholars from the Barcelona Supercomputing Center and the European Central Bank, paints a truly global picture. For instance, in California and Arizona vegetable prices increased 80% in November 2022 after the extreme drought, while in India a heatwave in May 2024 pushed up onion prices by 89 per cent. The study mentions one vital, yet often unacknowledged fact: all of this has likely impacts on public health. "When price increases shift consumer spending towards cheaper, often less nutritious options, or when climate extremes directly affect the prices of nutritious foods such as fresh fruit and vegetables, this can have knock-on consequences for the quality of diets." Markets are changing right before our eyes... and yet we remain blind. === Full study (open access): https://lnkd.in/dnm9x5W7 #climatechange, #sustainability

Inflation edges higher while tariff effects begin to emerge June’s CPI report came in a bit better than expected, with core inflation surprising to the downside. Early signs of tariff effects are beginning to emerge in the data, but remain limited so far. 🔹 Headline CPI rose 0.3% m/m while Core CPI rose 0.2%, just below expectations. 🔹 On a year-over-year basis, headline inflation accelerated to 2.7%, core to 2.9%. Underneath the surface: ➡️ Tariff effects are starting to emerge. Categories like clothing, household appliances, toys, and coffee saw price pressure--all sectors more dependent on imports in production. ➡️ Disinflation is still prominent. Travel and tourism continues to see weakness, and despite auto tariffs, new and used car prices fell. In services, owner’s equivalent rent registered its slowest annual increase since early 2022 while transportation services inflation cooled further. ➡️ Energy was a big driver, with gains in Gas and electricity prices. Grocery items were mixed — eggs fell 7.4% but those July 4th hot dogs were 9% higher. Despite new tariffs, the pass-through to consumers remains limited so far. Companies are navigating higher costs through: (1) Lower effective tariff rates (~9% actually paid vs. 14–18% headline rates) (2) Front-loading imports and timing lags between new tariff rates and collections. (3) Exporters abroad absorbing part of the tariff burden (i.e. Japanese carmakers) A better-than-feared report offered reassurance for markets today, but the risk of inflation either biting into margins or squeezing consumer purchasing power remains elevated. For the Fed, this report doesn’t bring decisive new clarity, keeping policymakers in wait-and-see mode as they look for further evidence of economic softness or reacceleration. 

Most of the core inflation data that has come in (with a lag) since Kevin Warsh was nominated in January has been moving in the wrong direction and core pce inflation is projected to exceed 3 percent this year. But the Fed has a dual mandate so what about the labor market? At the end of the day, assessing balance in the labor market requires more than looking at how many people are employed or unemployed. It’s also about wages gained adjusted for productivity, or unit labor costs. A year ago, there was speculation that tighter immigration enforcement under Trump 2.0 would constrain labor supply and push wages higher. That, in turn, was expected to lift inflation. So far, that has not happened. Wage growth has eased to 3.6 percent from 4 percent at the end of 2024, while productivity growth has picked up from 2.4 percent to 2.8 percent. The result has been a meaningful decline in unit labor cost inflation. Over the past three years, it has moved all the way back toward 2 percent, and over the past four quarters, it has fallen to just 0.5 percent! This matters because the Federal Reserve’s models, along with its institutional intuition, suggest that if the labor market is broadly in balance and inflation expectations remain anchored, core inflation should gradually move back toward target. What could derail that path? Two things stand out. Non-labor costs (think tariffs and memory chip prices) could rise; firms could also expand profit margins. Neither dynamic is likely to last indefinitely, which is why, in the long run, core inflation should move back in line with unit labor cost inflation. Of course, one thing economists are not very good at is telling us how long it will take to get to that “long run.”

Two major disruptions We have two major disruptive trends underway: 1. Measures of economic policy uncertainty, notably trade policy, have spiked. 2. Consumer sentiment measures reveal a surge in inflation expectations. Why do we care and what could they mean for the overall economy? First, let’s look at uncertainty. Heightened levels of uncertainty make us anxious. It is a basic human instinct to pull in or freeze when you do not know what is next; it is paralyzing. Economic research reveals that reticence. Firms and households tend to delay big investment and spending decisions. Banks are more cautious in their lending decisions, which amplifies the chilling effect on the overall economic activity. The pandemic represented an extreme case of uncertainty, until now. Global policy uncertainty measures spiked above the peak we saw during the pandemic. However, the fear of contagion - its own form of uncertainty - prompted firms and households to avoid or cancel high density forums and places of contagion. Employment plummeted by 1.4 million jobs between February 15, 2020 and March 14, 2020. The largest losers were leisure and hospitality and dental offices. That is prior to one country going into lockdown. Now, let’s turn to inflation. Recent consumer sentiment readings show a sharp spike in inflation expectations since December. That suggests that inflation expectations are not as well-anchored post-pandemic as they were pre-pandemic. We had a hard time getting up to the Fed’s 2% target in the 2010s; now we cannot seem to get down to it. We now know what a blistering bout of inflation is like and are faster to expect prices to increase in the face of a shock than in the past. That muscle memory is a dangerous and self-fulling prophecy for inflation. It both enables firms to raise prices with less pushback by consumers and can trigger hoarding. The scramble to buy eggs in the wake of price hikes due to the bird flu is a good example. Eggs are the largest source of inexpensive protein for households. Their surge in price has prompted a run on grocery stores and rationing by some major chains. That pushes prices up even faster and prompts rationing. It is reminiscent of what we saw toilet paper and hand sanitizer as the quarantines took hold. If sustained, the two disruptions together could be consequential. The worst case scenarios get us to stagflation. That is when inflation and unemployment rises in tandem. We have not seen a serious bout of that since former Federal Reserve Chairman Paul Volcker broke the back of inflation with two brutal recessions in the early 1980s. It would be optimal to avoid a repeat of that outcome today. Understatement.

Inflation-weary consumers are facing some new headwinds with word that companies are starting the year by passing through new price increases. The Wall Street Journal reports that after a period of holding the line and leaning on discounts late last year, many businesses are raising prices again, pointing to higher tariffs, labor costs, and health-insurance premiums as major drivers. This “real world” inflation doesn’t show up all at once in a single CPI print as we saw last week. But the risk is that it keeps pressure on the everyday cost of living over time. What does it mean for consumers? Even as inflation has cooled from its peak, affordability challenges are not going away. Price levels are broadly high and going higher, with the CPI up 26% from January 2020. New price hikes on clothing, appliances, and household goods can make it feel like the finish line keeps moving. In other words, disinflation is welcome, but it doesn’t automatically translate into relief when the items you buy and replace in normal life start climbing again. For the Federal Reserve, this is exactly the kind of backdrop that supports staying put with its benchmark short-term rate. The Fed can tolerate some “one-time” price adjustments, but policymakers worry about what comes next: higher input costs leading to broader price increases, then feeding into wage demands and service-sector inflation. That is how inflation becomes sticky. If companies regain pricing power, it makes the Fed less likely to cut rates quickly, because the risk is that inflation stops cooling and settles in above target. This is also why affordability is likely to remain front and center in the public conversation this year. Look for the president to try to address it in next week’s State of the Union. Ahead of this year’s mid-term elections, as voters talk about the economy, they don’t talk about the CPI. Instead, they mention whether the costs of groceries, housing, insurance, and basic household items are or are not manageable. And if businesses are raising prices again, that affordability pressure becomes harder for elected officials to ignore. Bottom line: inflation progress has been real; price levels generally continue to rise. The next phase may be choppier. Consumers should plan for a world where prices rise more slowly than they did in 2021–2022, but where affordability still feels tight, and rate cuts, if they come, are more likely to be gradual than rapid. Our advice for individuals and households is to prioritize paying down high-cost debt, focus on boosting income where possible, and to prioritize saving for emergencies while utilizing high yield savings accounts.

✨ The EY EY-Parthenon Macroeconomics Team is excited to present the July 2024 US Executive Briefing! 🧭 The US #economy is decelerating moderately as we pass the midyear point. Nothing alarming, but labor market momentum is cooling with initial claims for unemployment on a gentle uptrend, the unemployment rate creeping up past 4%, payrolls gently slowing, hours worked moderating, and wage growth easing. 💸 With real disposable income growth having slowed to a modest pace, #consumers are favoring prudence over exuberance. Lower and median-income households with higher debt burdens and weaker savings buffers are showing more price sensitivity and discretion in their purchases while higher-income families are still spending relatively freely. 🏢 #Businesses are also being more judicious with their hiring and investment decisions while offering discounts and incentives to draw more price-discriminating customers. The housing market remains largely frozen with limited supply and depressed affordability constraining demand. 🔮 Looking ahead, cost fatigue and general macroeconomic uncertainty around the elections, policy, and geopolitical developments will keep expectations in check. We foresee: 1️⃣ Real #GDP growth averaging 2.3% in 2024 and moving slightly below potential at 1.7% in 2025. 2️⃣ #Unemployment rate rising further toward 4.3% while job growth slows below trend. 3️⃣ Fed’s favored #inflation gauge, the deflator for personal consumption expenditures (PCE), ending the year around 2.5% y/y. 4️⃣ Two 25bps #Fed rate cuts before year-end, followed by 125bps of easing in 2025 if the economy evolves in line with our baseline. 🙌 Special thanks to Lydia Boussour, Marko S. Jevtic, Dan Moody, Harry S., Dipesh Khati, Eric Setiawan, Lilanthi Alahendra 📑 Join our monthly distribution list here: https://lnkd.in/dup3h4vW

It’s CPI #inflation data, which means it’s time to check in on what has been one of this cycle’s most important charts… … and it may not be so important anymore. Though there is plenty of debate remaining on the data and the economy, there is no longer much debate about the path of inflation. July’s #CPI figures affirmed the market’s emerging narrative that #growth – not inflation – represents the key risk to positioning ahead. A few notes on the report: At the highest level, the report had no surprises. Data came in line with investors’ expectations. Underneath the hood, higher prices on “must” have non-discretionary items, such as #shelter and insurance, are starting to crowd out the “nice to have” discretionary items. Prices for items like airfares and food away from home are moving lower. Disinflation has historically been challenging for corporations, who experience lower pricing power as a result. With economic momentum and price growth slowing, we may see macroeconomic conditions more firmly reflecting in Q3 #earnings. Shelter costs are still sticky. We are not concerned about shelter inflation in the medium term or as impacts Fed policy; data related to rents and new tenant applications suggest that shelter price inflation can move lower in the coming year. We are, however, mindful that sticky shelter prices can impact household spending on other items, especially when wage growth is decelerating. What does this mean for the #Fed? The Fed has clearly stated that it needed to see more data in line with recent prints – not better data – in order to justify a cutting cycle to begin in September. We believe this bar is amply met with today’s data. Economic momentum is slowing. For a Fed that is concerned about its balance of risks, and who considers its policy position already tight, it’s appropriate to expect a faster pace of normalization in the coming 12 months. The market is weighing the potential for a 50 basis point cut. Though there is still plenty of time to demonstrate otherwise, we don’t believe that today’s data represents an urgent need to cut 50 basis points in September. Even if data are slowing, the signs we would look for to signal a recession – such as a meaningful rise in jobless claims or deterioration in corporate outlook – are not yet flashing red. 

The latest U.S. macro data suggests a relatively steady economy has been hit by an energy shock. Consumers are clearly feeling the pinch: The Consumer Price Index (CPI) rose sharply in April, not only in the headline but also in the core measure – which excludes food and energy – as higher energy costs began to filter through broader goods and services. U.S. consumers remain a key engine of growth, but the signals are mixed. Many households saw lower tax bills (or larger refunds) after the One Big Beautiful Bill Act (OBBBA), giving them some spending flexibility just as gas prices spiked and real incomes came under pressure. Historically, consumers tend to smooth through energy shocks by dipping into savings and cutting discretionary spending. We’re already seeing early signs of that pullback in high frequency credit card data. That fiscal boost from OBBBA is likely to fade as we move into summer. Combined with higher gas and airfare prices, spending on leisure and summer travel could be soft this year. Policymakers – both at the central bank and on the campaign trail ahead of November – will be watching consumer data very closely.