Can Inflation Fall Fast Enough for the Fed?
Summary
- Federal Reserve unlikely to raise rates next month but for it to stay on sidelines, inflation needs to cool quickly
Inflation is still too high. That probably won’t lead Federal Reserve policy makers to raise rates when they meet next month, but unless inflation comes down significantly in the months ahead, Fed policy makers will lace up their boots and start hiking all over again.
Maybe it will.
The Labor Department on Wednesday said that its measure of consumer prices rose 0.4% in April from March, putting it 4.9% above its year-earlier level. Core prices, which exclude food and energy items to better reflect inflation’s underlying trend, also rose 0.4%, and were up 5.5% from a year earlier.
It has been worse: Overall prices were up 9.1% from a year earlier last June, and the year-over-year change in core prices hit 6.6% in September. Still, the cooling process has been far too slow. If not for the recent stresses in the banking system, coupled with uncertainty about the debt-ceiling imbroglio, the Fed would probably raise rates at its June meeting.
But those banking stresses are there, and while it is still early to assess how much of a drag on the economy tighter lending standards will cause, the Fed believes they will have an impact. When it raised rates last week, the Fed signaled it would hold off on raising rates again for now, and neither last Friday’s strong employment report or Wednesday’s inflation report change that.
There were some aspects of the inflation report that will please the Fed. It has been focusing on what has been termed supercore inflation—the change in services prices excluding energy and housing costs. This is firstly because services prices are more closely linked to U.S. wages, as opposed to prices for goods, which are more driven by global demand, and which have been whipsawed by supply-chain problems since the pandemic started.
Housing prices are excluded because they are affected by changes in rents, used by the Labor Department to measure not just renters’ costs, but to impute changes in housing costs to homeowners. But the Labor Department’s reading on rents lags behind what has been happening to rents on newly signed leases which measures from private sources—such as Zillow—show have been cooling rapidly. (The Fed’s preferred gauge of inflation, from the Commerce Department, employs the Labor Department’s rent readings.)
In April, supercore inflation rose just 0.11% from a month earlier, calculates Omair Sharif, founder and president of the advisory firm Inflation Insights, after rising 0.4% in March, marking the slimmest monthly gain since last July. The data can be noisy, so he cautions against reading too much into it, but it is still a step in the right direction.
The key will be for signs of cooling inflation to mount over the summer months. The best outcome would be for that to happen without lending conditions tightening to the point that the economy gets pushed into a recession. The worst would be for a recession to hit while inflation is still too high.
Write to Justin Lahart at Justin.Lahart@wsj.com
