Consumers set their inflation expectations based on a range of factors. Exposure to price signals like groceries and gasoline, central bank communications, lifetime experiences and economic sentiment are but a few of the factors that shape individual behavior and determine inflation expectations.
The price shock of 2021 and the subsequent rate hikes by the Federal Reserve are still having an impact on U.S. households. Consumers have sent one-year and three-year inflation expectations to above 3%, according to the New York Fed’s Survey of Consumer Expectations.
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The recent imposition of a 25% tax on most imports from Mexico and Canada, as well as a 10% tariff on goods from China on top of the 10% tariff that was already there, is likely to at best slow the goods deflation that has been the primary cause of a slower growth in the price level over the past two years.
Perhaps more challenging in the anchoring of inflation expectations will be the impact of tariffs on food imports, which at this point have no exemption.
One suspects that this will be the biggest surprise for the majority of consumers who do not face large food taxes in the jurisdictions where they shop.
While a 5% to 10% depreciation of the Canadian dollar or Mexican peso will partially offset the 25% tax, and importers will eat some costs through compressed margins, that still implies double-digit increases in many grocery items given the quantity of fruit and vegetables imported from those two countries.
