The latest data on inflation indicates a reversal in the progress made towards cooling price growth, with two key measures showing an increase rather than a further slowdown towards the Federal Reserve’s 2% annual target.
The surge in inflation was primarily driven by sticky prices in the services sector, particularly in housing. According to the latest personal-consumption expenditures index data released on Thursday, services prices rose by 0.6% monthly in January, double the 0.3% increase reported for December. This marked the fourth consecutive month of increasing service inflation. On an annual basis, service prices rose by 3.9% last month.
Similarly, the Bureau of Labor Statistics reported on Feb. 13 that an index of services costs, excluding energy, increased by 0.7% in January, up from the 0.4% rate reported for December.
The acceleration in services inflation has raised concerns among several Federal Reserve officials, who have cautioned against quickly lowering interest rates this year. Richmond Fed President Thomas Barkin emphasized the need for more progress in lowering services and rent prices before considering interest rate cuts.
Atlanta Fed President Raphael Bostic echoed this sentiment, stating on Thursday that recent inflation readings suggest a non-linear path towards the 2% target, with potential bumps along the way.
Meanwhile, prices for goods declined by 0.2% in January and 0.5% year-on-year, according to data released by the Bureau of Economic Analysis on Feb. 29. This divergence in the trajectory of prices for services and goods indicates distinct trends, with services inflation accelerating while goods prices are on a downward path.
Chris Clarke, an economics professor at Washington State University, suggests that the variation in inflation between goods and services might not pose as much of a problem as some Fed watchers fear.
The price growth of goods was largely driven by pandemic-related factors such as supply-chain disruptions, product shortages, and pent-up consumer demand. However, as the effects of Covid have waned and the global economy has normalized, these conditions have eased, leading to a slowdown in goods inflation.
On the other hand, high services inflation is primarily driven by a tighter labor market and wage growth. However, there are indications that labor conditions are returning to normal, and wage growth is expected to slow down this year. For instance, job-quit rates have leveled off below pandemic highs, suggesting that workers are less inclined to change jobs in search of higher wages. Additionally, the Employment Cost Index revealed that employers’ compensation outlays grew by just 4.2% during the fourth quarter of 2023, marking the sixth consecutive quarter of slowing wage growth.
Higher wages bring benefits such as fueling consumer spending and reducing broader wage inequality, particularly among lower-wage workers. However, this can also lead to increased prices for goods and services, as seen in the case of the Big Mac. Clarke highlights that the apparent cheapness of certain goods before may have been due to reliance on poverty wages.
January’s economic data can be noisy due to annual pricing changes and minimum-wage hikes, making it important to interpret trends carefully. For instance, February’s data might present a different perspective on the trajectory of services inflation compared to January.
Monitoring housing costs within inflation data is crucial. Despite expectations for a slowdown, shelter price growth, a significant component of the consumer price index, has not slowed as anticipated. If housing costs remain high, it could lead policymakers to delay rate cuts, with investors currently expecting such cuts to commence in June.
The release of February’s consumer price index data on March 12 and the Fed’s latest economic projections on March 20 will provide further insights. Despite recent higher-than-expected inflation readings, the overall trend suggests a downward slope, according to Bostic, emphasizing the importance of a long-term perspective.