There was much rejoicing last week as June’s headline CPI came in at three percent, the lowest level of overall price level growth since March 2021. Financial media declared that the U.S. has entered “disinflation mode” and that the season of post-pandemic inflation was nearing an end. The previously scorned word “transitory” was reintroduced to inflationary discourse.
While the reduction in headline CPI to three percent from last June’s 9.1 percent was certainly welcome, discussion about the “end of inflation” is at a minimum premature and quite possibly misses the point altogether.
It’s time for an inflation reality check. Core inflation (which excludes volatile energy and food prices) remains stubbornly high at nearly five percent, and overall price levels are up nearly 20 percent since June 2020. Until both core inflation comes down and wages catch up with what appears to be a permanently higher overall price level plateau, inflation will remain a non-transitory problem.
Overall price level growth, as measured by headline CPI, has slowed for the past twelve months. This is largely driven by energy prices which have fallen sharply from last summer. However, with the exception of energy, prices for many goods and most services are still rising too fast. The dramatic decline in energy costs (gasoline prices were down over 26 percent from last June, for example) masks the continued rise in other important categories. By way of example, in June Transportation prices rose by 8.2 percent, Shelter by 7.8 percent, while food and electricity prices each rose by over five percent (5.7 and 5.4 percent respectively). Other categories are faring worse, with motor vehicle insurance prices rising by a stunning 16.9 percent since last year.
When energy and food are excluded, Core CPI remains high at 4.8 percent growth in June, following a 5.3 percent increase in May. June was the first month since November 2021 in which Core CPI dipped below five percent, but the Federal Reserve knows it still has a long way to go before it can declare victory.
The unpleasant reality that all Americans should remember is that the overall price level has increased by nearly 20 percent since 2020, and by much more in the categories most relevant to most households. Even with the recent large decline in energy prices, fuel oil and gasoline prices remain 82 and 71 percent higher than they were in June 2020. Utility gas and electricity are up 30 and 24 percent, respectively. Used car prices remain 47 percent higher and overall food costs are up nearly 20 percent. Shelter has trailed headline inflation at just under 17 percent, but the category nonetheless represents a large portion of household spending and thus marks a substantial increase in the cost of living. Basically, everything that consumers need: food, shelter, transportation, and energy, remains prohibitively expensive.
There is some good news. Wage growth is accelerating as workers demand more from employers. Nominal wage growth for June 2023 was 5.6 percent, above both headline and Core CPI. However, wages still have a way to go to catch up with three years of inflation. Since June 2020, nominal wages have grown by 16.3 percent, a period in which headline CPI grew by 18.4 percent. Those who changed jobs managed to increase nominal wages by 18.7 percent, while those who remained loyal and stayed with the same employer for three years have lagged at 15.3 percent nominal wage growth.
The U.S. seems to be exporting inflation to Europe—which is more directly impacted by the Ukraine conflict—and absorbing goods deflation from China, both which appear to be helping to moderate overall price levels in the U.S.
In summary, before the Biden administration can declare an end to inflation, Core CPI must come down, wages need to catch up with overall price levels without overshooting and thus driving another round of price increases, and the U.S. needs to avoid a return to energy driven inflation. Thus far in July, crude oil prices have risen ten percent from June’s lows, but remain below the threshold $80 per barrel and well below last summer’s high of $100 per barrel. As such, this poses no particular inflationary threat unless there is an external event that shocks the market. The biggest risk factor to energy prices continues to be the war in Ukraine and the question of whether China will manage to stimulate economic growth, which has been remarkably disappointing so far this year. In the meantime, odds are still on for a 25 basis point (0.25 percent) interest rate increase by the Federal Reserve’s Open Market Committee when they meet later this month.
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