Nothing in January’s consumer price index data released on Thursday implies that the surge in inflation has peaked. Last month’s CPI increase will add to the difficult choices at the Federal Reserve on the magnitude of the interest rate hikes that make up the next step of its policy normalization.
The top-line increase of 0.6% in January and 7.5% on a year-ago basis will intensify market speculation about a 50 basis-point hike at the Fed’s March meeting.
The primary drivers of inflation continue to be energy, transportation and industrial goods. While transportation costs will fade as supply chains normalize, the sustained increase in the cost of shelter and owner’s equivalent rent imply that inflation is not going to return to the Fed’s inflation target of 2% this year or next.
The top-line increase of 0.6% in January and 7.5% on a year-ago basis will intensify market speculation about a 50 basis-point hike at the March meeting.
A strong economy, a labor market on fire and a 5.7% increase over the past year in housing costs that comprise 42.3% of the index should create a sense of urgency among American central bankers on the use of both conventional tools—hiking the federal funds rate—and unconventional tools—drawing down the balance sheet and the potential selling of mortgage-backed securities—to address soaring inflation.
While we think that the Fed can curate a soft landing of the economy, that policy objective is growing more difficult.
The policy-sensitive owners’ equivalent rent increased by 0.4% for the fourth consecutive month and is up 4.1% on a year-ago basis. Rent of primary residence increased by 0.6% while lodging away from home declined by 4.1%.
While the pace of increasing costs inside the core index eased somewhat, inflation continued to broaden out inside the index—an indication of the significant policy challenge that the Federal Reserve faces. Moreover, the fiscal authority is going to have to create the conditions for an acceleration in the construction of homes to address the rising costs of shelter.
In our estimation, the increase in the cost of shelter, which is a function of the shock induced by the pandemic and mobility that followed, will be a significant policy challenge that will have to be addressed not only through the monetary channel but also through the fiscal channel.
The sad truth is that the U.S. economy is close to half a million homes short of where it should be and the fiscal authority must put forward a series of incentives to stimulate the building of homes to support the demographic and economic changes that are taking place.
To overcome the not-in-my-backyard movement in many major metropolitan areas, the Biden administration and its allies in Congress are going to have to overcome that objection of many to address what will be a medium- to long-term challenge to price stability.
The data
Excluding food and energy, inflation increased by 0.6% and is up by 6% on a year-ago basis. Excluding food prices, inflation increased 0.6% and is up 7.6%. Excluding energy, inflation costs advanced 0.6% and 7.6% over the past year. Excluding food, energy and shelter—46.3% of the index—costs increased 0.8% and are up 7.2% on a year-ago basis.
Beneath the top-line number, the cost of energy increased 0.9% on the month, food advanced at a 0.9% pace, services climbed 0.6% and housing rose 0.7%. The cost of apparel jumped 1.1%, transportation rose 0.4% and medical care increased 0.7%.
Inside the transporation portion of the index, the cost of new vehicles did not change while used cars and trucks advanced 1.5%, which was less than half of the 3.3% increase in December.
The cost of recreation advanced 0.9%, commodities 0.8% and food and beverages 0.8%.
The takeaway
Rising inflation costs will continue to create headaches for American households and the commercial sector. These challenges will drive policy choices at the central bank, which will pursue a tightening in financial conditions for the foreseeable future.
The two major questions that remain are: Will the Fed overdo it and create the conditions for a premature end to the business cycle in 2023 or 2024? And will the fiscal authority step forward and address the significant shortage in housing to address what will be a medium- to long-term challenge in the cost of shelter?
