Weekly Economic Trends & Indicators

The Headline

Inflation continues to be a stubborn problem for the U.S. economy. This week saw two important data releases from the Bureau of Labor Statistics (BLS). On Tuesday, the BLS announced that the consumer price index (CPI) increased at a seasonally adjusted 0.5% rate in January. The inflation rate over the previous 12 months was 6.4%. On Thursday, the producer price index (PPI) was released, also by the BLS. The PPI for final demand increased by a seasonally adjusted 0.7% in January. Over the previous 12 months, the PPI for final demand increased by 6.0%

The Details

The CPI inflation rate was higher than expected, but only slightly. The January increase in shelter costs, largely consisting of rent, accounted for much of the increase. Also contributing to the rise were the prices of gasoline and natural gas. Used cars continued their months long price decline. On the producer side, energy costs also led the price increases.

The Context

When policymakers poured money into the economy to keep markets from collapsing during the COVID-19 pandemic in 2020, many economists warned that inflation could result down the road. We relied on the Federal Reserve to take that stimulus out of the economy before inflation had a chance to become entrenched. By late 2021, it was widely acknowledged that inflation was beginning to rise. Soon after that, Russia’s invasion of Ukraine was a turning point for inflation expectations, which jumped not only in the U.S., but Europe as well. Once higher inflation expectations begin to take hold, it can become more difficult to bring inflation under control without provoking a recession. This is why the Fed began raising interest rates with a sense of urgency last year. That urgency was meant to convince the public that the Fed took its responsibility seriously and thus reverse the public’s expectations of future inflation.

For the past few months, it has looked like the tightening was working as inflation began to slow down from its breakneck pace with many pundits hopeful that the rate increases would soon end. However, many others were not prepared to declare victory just yet. Their message was that there were likely to be ups and downs on the path to price stability, but even so policymakers must stay the course. While January’s price increases were somewhat higher than desired, the long term trend continues to move in the right direction. Two steps forward with one step back still moves you closer to the goal.

While there is still a reason for cautious optimism, this week’s data caused some in the market to revise their expectations for how high interest rates will need to rise this year to wring all the inflationary pressure out of the economy. Another 50 basis point rate increase, while not certain, is back on the table. This also increases the risk of policy error leading to recession. Avoiding a recession is still possible, but getting the timing right on when to pause the rate hikes is becoming ever more critical.

Next week: Housing market update.