Why inflation is worrying markets and economists

As inflation began to accelerate in 2021, price pressures were pandemic-driven: supply chain disruptions prevented companies from producing cars, sofas and video games fast enough to meet consumer demand confined to their homes.

Posted at 7:00 am

Jeanna Schmalek
The New York Times

This year, the war in Ukraine has pushed up fuel and food prices and increased price pressure.

Now that these sources of inflation are showing signs of slowing down, the question is how much will the overall inflation slow down. The answer will likely depend in part on what is happening in one crucial area: the labor market.

brake momentum

Federal Reserve officials are focused on job creation and wage growth while rapidly raising interest rates to rein in the economy and curb soaring prices. Officials are convinced they will have to steal some of the momentum from the economy to bring inflation back to its 2% target, the worst in four decades.

They do this by slowing spending, hiring and pay increases, and increasing the cost of borrowing. So far, a sharp slowdown has proved elusive, suggesting to economists and investors that the central bank may need to be even more aggressive in its efforts to dampen growth and lower inflation.

As this week’s data has shown, prices continue to rise. And although the labor market has slowed somewhat, employers are still hiring at a fast pace and raising wages at the fastest pace in decades. This continued progress seems to allow consumers to keep spending and could give employers the power and incentive to raise prices to meet their rising labor costs.

An inevitable recession?

Economists say as inflationary forces gather, the risk increases that the Fed will rein in the economy enough that the United States faces a hard landing, which could lead to a slowdown in growth and a rise in unemployment.

It’s becoming more and more likely “that it won’t be possible to push inflation out of this economy without a real recession and rising unemployment,” said Krishna Guha, who heads the global policy and central bank strategy team at Evercore ISI, predicting that the Fed could curb inflation without triggering a recession.

The challenge for the Fed is that rate hikes appear to be increasingly driven by long-term factors related to the underlying economy and less by one-off factors caused by the pandemic or the war in Ukraine.

August CPI data, released on Tuesday, illustrates this point. Gasoline prices have fallen sharply over the past month, which many economists believe should lower headline inflation. They also believed that recent supply chain improvements would dampen the rise in commodity prices. The cost of used cars, a major contributor to inflation last year, is now falling.

“A very dynamic job market”

Despite these positive developments, rapidly increasing costs for a wide range of products and services helped push up prices on a monthly basis. Rent, furniture, restaurant visits and visits to the dentist are becoming more and more expensive. Inflation rose 8.3% yoy and 0.1% mom.

The data underscores that even in the absence of exceptional disruption, so many products and services are now increasing in price that costs could continue to rise. Core inflation, which excludes food and fuel costs to give an idea of ​​underlying price trends, accelerated to 6.3% in August after falling to 5.9% in July.

“Inflation has a very large underlying component right now, which is being driven by a very buoyant labor market,” said Jason Furman, an economist at Harvard University. “And then there can be more or less inflation every month just because the price of gas changes. »

He estimated that core inflation would continue to rise to around 4.5% and rise even if pandemic- and war-related disruptions stopped pushing prices higher.

War-related inflation and supply chain disruptions are not entirely behind the US – fighting continues in Ukraine and a rail strike that threatened to disrupt critical US transit routes was narrowly averted on Thursday thanks to a tentative agreement. But encouraging signs show that these two phenomena are beginning to unravel.

Supply chains began to unravel and prices for oil and some grains fell after skyrocketing during the Russian invasion of Ukraine.

This could pave the way for a steady slowdown in consumer price inflation, which would help determine how far and how fast inflation can fall. The answers to these questions will depend more on the basics.

Balancing supply and demand

“The most important question for the Fed is not: has inflation peaked? It is: What is the goal? said Aneta Markowska, chief financial economist at Jefferies. She believes it will be difficult to bring inflation below 4% without a significant slowdown in the economy and jobs – double the Fed’s average target of 2%.

“You still have housing and jobs, and there’s still a lot of inflationary pressures from those two areas, which are very unbalanced,” she said.me Markowska.

For this reason, the Fed, which meets next week, is trying to rebalance supply and demand.

Central bankers raised interest rates to a range of 2.25%-2.5% from near zero in March at their last meeting and are widely expected to raise them by at least another three-quarters of a basis point next week. The Fed’s actions represent its fastest rate hike campaign since the 1980s. The goal is to make borrowing more expensive, which in theory should slow consumer spending, increase supply, catch up, and encourage companies to lower prices to lure customers.

After the worrying inflation data released on Tuesday, investors began speculating that the authorities could make an even more drastic rate hike next week or that they could push higher-than-expected rates into the economy.

But if the Fed decides it must tighten the economy more in the coming months to meet its targets, as investors are increasingly speculating, it could come at a price.

Central bankers have hoped to slow down the economy enough to reduce job vacancies without damaging them enough to drive up unemployment. Some economists believe that this is still possible in view of the currently unusual situation on the labor market.

However, a faster and more drastic series of rate hikes would increase the risk of a sharp slowdown in growth, which would push up unemployment.

This article was originally published in The New York Times.

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