This is the latest sign that Americans are experiencing sharp price rises that will likely get worse after Russia’s invasion Ukraine.
Core inflation rose 5.2% in January, excluding volatile food and energy prices. The Commerce Department reported Friday in its monthly personal consumption expenditures index (PCE).
Inflation has been high due to robust consumer spending and widespread shortages of product and workers. This is a significant burden on American households, particularly those with lower incomes who are faced with rising fuel, food and rent costs. Americans are becoming more pessimistic about the economy. The University of Michigan’s Consumer Sentiment Index fell to its lowest level for over a decade.
Gus Faucher, the Chief Economist at PNC, stated in an email that inflation is “a major concern”. “With PCE inflation at its fastest pace for four decades, rising prices are consuming real incomes as well as savings.
To temper inflation, the Federal Reserve indicated that it would raise interest rates in 2019. However, this will make borrowing more expensive, which will affect everything, from mortgages to credit cards. Due to rising energy prices, the Russia-Ukraine conflict could increase inflationary pressures. Analysts believe this could make it more difficult for the Fed to raise rates aggressively than Wall Street had previously anticipated.
Consumer spending
Consumers as a whole seemed to ignore the increased prices and have increased their spending by 2.1% between December and January, according Friday’s report. This is a positive sign for the economy, and the job market.
This was a marked improvement on December’s spending decline. Americans from all income levels have received pay raises and amassed more savings since the pandemic of two years ago. This increased savings pool provides fuel for future spending.
“The strong consumer numbers are at a moment when many economists were concerned about an economy that was weaning its self of government stimulus in late 2021, and whether or not the consumer would have the ability to carry the torch into 2022,” Peter Essele of Commonwealth Financial Network’s portfolio management, stated in an email.
He said, “It seems discretionary spending is still strong, likely buoyed a rising incomes as the result of a tight labor market.”
However, inflation is likely to continue rising and may accelerate in the next months due to Russia’s invasion of oil and gas exports. Other commodities such as wheat or aluminum that are made in Ukraine have also seen an increase in their prices.
Thursday’s statement by President Joe Biden was that he would do everything possible to maintain gas prices under control. Although he did not give specific details, he suggested that the possibility of more oil being released from the nation’s strategic reserve. He warned that oil companies and other gas companies should not “exploit this moment” and raise prices at the pumps.
Oil at $100 per barrel
Oil prices held steady on Friday after reaching $100 per barrel in volatile trading Thursday before dropping back to $92, which was close to the level they were at one hour earlier. JPMorgan economists have predicted that oil could rise to $110 per barrel as Russia’s invasion in Ukraine intensifies. BMO Capital Markets economists estimate that every $10 increase in oil prices will translate into an inflation rate of 0.4 percentage points.
A separate report on Friday revealed that long-lasting factory goods orders rose sharply in January due to a rising demand for aircrafts. These figures show that companies are more willing to invest in industrial equipment, which is a sign of economic confidence.
Paul Ashworth, chief U.S. economist, Capital Economics, a forecasting company, stated that “Overall, it appears to be in better health than we feared.”
Growth in wages
Last month’s incomes remained the same due to the expiration of Child Tax Credit payments, which were part of Biden’s $1.9 billion financial support package. A new study found that child poverty rose after the payment ended.
According to Friday’s report, wages and salaries increased 0.5% between December and January. A large cost-of living adjustment reflecting the increase in inflation last year, led to Social Security payments increasing.
Russia’s invasion and the likely rise in inflation have put more pressure on the Fed. The Fed is expected to raise interest rates 25% as often as five to six times this year, starting in March. Now, the delicate task of raising rates to contain inflation without causing a recession has become more difficult for the Fed.
Inflation is usually accelerated by higher gas prices, which could lead to more rate hikes. However, higher gas prices can also slow down consumer spending and weaken the economy. This would lead to the Fed leaving rates the same.
Fed’s rate-hike plan
Officials at the Fed acknowledge that the invasion by Ukraine has impacted the economic outlook but insist that they will continue to pursue their rates hikes.
Loretta Mester, President of the Federal Reserve Bank of Cleveland said Thursday that she supports a series of rate increases beginning in March. She said that the Fed should be flexible. If inflation hasn’t started to decline by mid-year, then faster or steeper rate increases might be necessary. However, gradual increases may be required if inflation slows.
She said, “The implications of Ukraine’s unfolding situation for the medium-run U.S. economic outlook will also be considered.” Similar remarks were made by other Fed officials this week.
Late Thursday, Fed governor Christopher Waller said he would support a half-percentage-point rate hike in March if inflation remains high. But most officials have said they’d prefer to raise rates by the traditional quarter-percentage-point increment.
Fed officials hope inflation will return to the Commerce Department’s 2% target. The gauge was released Friday. The consumer price index, which was released two weeks ago, shows that inflation rose to 7.5% in January, a four-decade record.
Forecast of inflation
Fed officials predicted that inflation would fall to 2.6% according to their preferred measure by December. This is a prediction most economists consider increasingly unlikely. At its March meeting, the Fed will release revised projections.
The January data shows that inflation was already rising before the invasion. Prices rose 0.6% from December to January, compared with 0.5% the month before.
Early signs suggest that February has seen a rebound in consumer spending, thanks to the rapid disappearance of the coronavirus omicron wave. JPMorgan Chase reported that spending on credit cards for hotel rooms, airline tickets and restaurant meals increased in the first half this month.
JPMorgan Chase Institute recently released data that showed cash balances are still high among customers, even those with lower incomes. The bank account balances of Americans earning less than $26,000 a year were 65% higher than the two-year prior.
Combining higher wages and increased savings may mean that Americans will be able continue spending at a steady pace over the next few months to sustain the economy’s inflationary pressures.
