In April, US inflation, as measured by the consumer price index (CPI), eased to 8.3% year-on-year (yoy) from 8.5% in March. Also core inflation, which excludes energy and food, fell to 6.2%. Nonetheless, inflation remains well above the Federal Reserve’s 2% objective.
In this edition of Infocus we analyse the impact of four factors on the inflation outlook in coming months:
- the base effect;
- the prices of food and energy raw materials;
- supply chain bottlenecks;
- the real estate market.
The base effect is expected to lower inflation, measured as the change in prices over twelve months, over the next few months. The change in annual inflation from month to month is approximately equal to the difference between the new monthly price change and that recorded in the same period twelve months earlier. The stronger the monthly rates of inflation over the past twelve months, the more likely it is that annual inflation will decline when they drop out of the calculation. This is the current case: the average monthly increase in the CPI in the period May 2021-March 2022 was 0.7%, much higher than the 0.2% recorded since 1990. This strong base effect points to lower inflation in the coming months.
However, the favourable base effect is no guarantee that inflation will fall quickly. Consider the recent increases in energy and food prices: these explain a large part of the rise in inflation and their contribution is expected to moderate in the future. Yet despite this benign medium-term outlook, the war in Ukraine has resulted in commodity prices remaining higher for longer. There is clearly a risk that energy and food prices will remain at high levels in the coming months, limiting the decline in inflation during the rest of the year.
Another factor that could slow the decline in inflation is the persistence of global supply chain bottlenecks. The new anti-Covid lockdowns in China since last March have again lengthened the delivery times of manufactured goods, as reflected in the lower PMI sub-index. Falling PMI delivery times correspond with increases in the Global Supply Chain Pressure Index (GSCPI) developed by the Federal Reserve Bank of New York, which is positively correlated with the US inflation rate.
Turning to our fourth factor, rising house prices in the US are symptomatic of the effects of supply shortages. The combination of anti-covid measures and delays in the delivery of building materials alongside the increase in demand resulting from low interest rates and high savings has reduced the stock of houses available on the market. As a ratio to monthly sales, the stock of houses for sale covers less than three months, a level not seen even at the dawn of the housing bubble in 2005. Unsurprisingly, house prices have risen: the annual growth of the Office of Federal Housing Enterprise Oversight house price index, which was only 6% yoy at the beginning of 2020, has been above 18% yoy since May 2021.
In conclusion, the April decline in US inflation suggests that the peak is finally behind us. However, the short-term scenario for prices remains uncertain and several factors suggest that inflation, while moderating, will stay high for the remainder of 2022 and in early 2023. There is a risk that the Federal Reserve's March projections are overly optimistic regarding the anticipated decline in the inflation rate by the end of 2022.