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The US consumer price index increased 0.8 percent month on month in February, bringing the annual rate of inflation to 7.9 percent, a new 40-year high.
It will soon be close to 9% as rising commodity and labour costs are passed on to consumers.
Food rose 1% MoM and energy rose 3.5 % MoM, resulting in core inflation of 0.5 % MoM/6.4 % YoY when these items are excluded. All of this is in line with market expectations.
While supply chain strains and labour shortages are important drivers of inflation, we must also remember that strong stimulus-supported demand is also a factor. Goods price inflation is extremely high, as evidenced by the fact that retail sales are currently 24 percent higher than they were in February 2020.
In this high-demand environment, corporate pricing power is at multi-decade highs, allowing businesses to pass on cost increases to customers.
According to the National Federation of Independent Businesses, the broadest range of businesses are raising their prices – a net 68 percent raised them last month, and we are close to a record for the proportion of businesses expecting to raise them further in the next three months. Inflation will remain well above 2% for the rest of the year.
Inflation will rise further in the near future. The increase in gasoline prices to $4.25/gallon from $3.50 in February will be enough to push headline inflation above 8.5 percent in March.
Furthermore, rising labour and agricultural and metal commodity costs will inevitably translate into higher input costs for businesses. In a strong corporate pricing environment, as highlighted by the NFIB chart, it will be passed on to consumers in the coming months, so we cannot rule out 9 percent inflation.
This will erode consumer spending power and is likely to result in lower consumer activity than would otherwise be the case. Nonetheless, the economy is gaining momentum and creating a significant number of jobs. Given that there are more than 1.7 vacancies for every unemployed person in the United States, corporations are clearly desperate to hire and are willing to raise wages to attract workers so that incomes can continue to rise.
Despite the uncertainty caused by Russia’s invasion of Ukraine, the Fed has indicated that it will raise the fed funds rate by 25 basis points next week, with a series of rate hikes likely.
The geopolitical backdrop is obviously difficult to predict, but our central case is for five additional 25bp rate hikes this year, bringing the fed funds rate to 1.5-1.75 percent by year’s end.
The Russia/Ukraine situation is unsettling, but the US economy is gaining momentum and appears to be resilient.