ECONOMIC OUTLOOK OP-ED
Where is the evidence that the battle against US inflation has been won?
US consumer inflation may have peaked in July – or maybe not. Energy prices are working in favour of lower inflation in the months ahead, but food prices are not. Until food prices join the party, it’s too early to celebrate that the battle against inflation has been won.
There was a collective sigh of relief when US consumer price inflation came in below expectations last week, seemingly confirming inflation in the world’s largest economy had peaked. But, as economists rightly remind us, one month’s data does not a trend make.
So, what do the underlying trends say about what we can expect from the inflation data in the months ahead – and what are the risks that could disrupt this hopeful picture?
At a headline level, the eagerly anticipated US consumer price inflation rate came in at 8.5% versus June’s 9.1%, with core inflation at 5.9% in July. Month on month, the headline index significantly experienced no increase. Then producer price inflation was also a positive surprise, declining to 9.8% from 11.3% in June.
Energy prices are certainly leading the turnaround, with the Energy Index falling 4.6% between June and July, brought down by the 15%-plus declines in oil prices from their mid-June highs. When it comes to food prices, however, the trend was not nearly as encouraging, with the Food Index rising 1.1% month on month.
On the energy front, Investec economist Annabel Bishop says expectations of falling demand as a result of weakening global growth has been behind the decline in oil and gasoline prices. Gas and coal prices, however, remain high because of sanctions imposed on Russia in the ongoing war. She notes energy prices are also still high, with the Energy Index up 32.9% on a year ago.
Her interpretation of the latest data: “The lower inflation figures also reflect some start to the normalisation in price pressures following the surge in demand post-Covid, which drove prices higher, although it should be noted that the inflation measures are still at high levels, and have only seen mild subsidence.”
Of most concern regarding the inflation outlook is that there are no convincing signs of food prices turning the corner too – and until then, it would be premature to begin celebrating a peak in inflation.
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Oxford Economics senior economist Tamara Basic Vasiljev says: “Even though core inflation has peaked in countries where policy tightening took hold, food inflation has yet to turn. US saw the June food inflation print come down, but July is higher again. UK is still waiting for a peak in food inflation, though core turned a few months ago.”
The historic tendency is for food prices to be much stickier than other non-discretionary items (those goods that individuals have no option but to buy) – a phenomenon aptly described in the saying, “food prices go up like a rocket and come down like a feather”.
The situation is complicated by the fact that central banks’ behaviour is guided by year-on-year increases in prices, whereas for the person on the street, it’s the prices they see on the shelves that drive their behaviour. When it comes to the former, Vasiljev says central banks do not need, or want, proper price deflation (when prices come down in absolute terms) – they just want the upcycle in prices to come to an end.
Deflation in food prices is rare because they tend to be among the stickiest prices. This is evident in the food and non-alcoholic beverages inflation trends over the last few decades. Vasiljev points out that since the 1990s, food price deflation in the US and UK was only experienced for a short period during the global financial crisis. In South Africa, there’s been no food deflation since the mid-2000s, when records began.
There are a variety of factors contributing to the far slower decline in food prices than in other consumer price categories. It is costly for retailers to reprice food items and thus they tend to wait until they can be certain that economic conditions have normalised and food prices are no longer likely to rise.
However, uncertainty still prevails. For instance, commodity price moves are still vulnerable to developments in the war. It’s not sufficient to bank on the recent softening of wheat prices, as Ukraine supplies finally get to market when the war still rages.
Then, prospects of recession cannot be ruled out until the central banks begin to relax monetary policy and the impact interest rate hikes and quantitative tightening have had on the global economy becomes clear.
On the stickiness of food prices, Vasiljev says: “Food prices do not lead the downcycle, they lag it. Levels are very persistent but change is even slower than in other goods and services categories. You could thus expect it to take a while longer for food inflation to subside.
“First the policy tightening needs to take hold, then the more price-elastic goods and services turn, last comes the retail food. And then there are the hard-to-predict energy prices.”
Other categories in the consumer price index that would also need to come off the boil before the US Federal Reserve would be confident it had broken the back of inflation, are the costs of so-called shelter, with rents on primary residences still rising a heady 6.3% year on year, and labour costs, which have been buoyed by the strong labour market.
The Federal Reserve Open Market Committee (FOMC) meeting minutes do give insight into where the central bank currently stands and what it needs to see before it will adjust its stance. The minutes released this week have broadly been represented as balanced. Statements that were interpreted as relatively dovish included the central bank pointing to there being “some tentative signs of a softening outlook for the labour market”.
It also signalled a broadening of its scope of interest, saying that “as the stance of monetary policy tightened further, it likely would become appropriate at some point to slow the pace of policy rate increases while assessing the effects … on economic activity and inflation”.
On the other side of the equation, the Fed was still conscious of the continued risk that elevated inflation could become entrenched. Bishop expects the FOMC to wait to see a few months of declining inflation “before easing back on its very hawkish stance”.
She says the outcomes between now and the next Fed and SA Reserve Bank meetings are unlikely to turn their hawkish stances into dovish ones, and that we can expect, at best, 50 basis point (bp) instead of 75bp rate hikes at the next two meetings.
Vasiljev adds that even if the FOMC decides to scale back its rate hike to 50bps on 21 September, there will be another 125bps increase in the Fed funds rate by the end of the year.
The financial markets have been remarkably tempered in their response to the minutes after their bullish turnaround of late. Based on the available evidence, this caution seems appropriate until the currently divergent inflationary forces align. BM/DM