More than a year after the Federal Reserve unleashed a barrage of interest-rate hikes to tame inflation, price pressures are moderating, though not as quickly as policymakers would like. As recently as March, officials on the central bank’s rate-setting committee were forced to raise their outlook for core inflation, as measured by the personal consumption expenditures price index, this year to 3.6% from the 3.5% they’d projected back in December, underscoring how their 2% target remains elusive.
Economists continue to debate what’s keeping inflation high—or “sticky,” in professional parlance—even as borrowing costs have surged. The issue is that while prices for food, everyday household goods and energy have moderated, those for many services have continued to rise. Shelter, which amounts to about a third of the consumer price index, clocked a 0.6% increase in March, which was an improvement over the previous month. But costs for other services including air travel, education and car insurance continued to climb.
Many, including Fed Chair Jay Powell, trace the price pressures in services to an extraordinarily tight job market: Unemployment, at 3.5%, is close to the lowest it’s been in 50 years, and that puts upward pressure on wages.
How these dynamics play out will determine whether inflation returns to the Fed’s comfort zone without a recession or proves more persistent than expected—forcing the central bank to push interest rates higher, which could result in an economic downturn. Traders are banking on another 25-basis-point hike when policymakers next meet on May 2-3.
“We still have a long way to go in terms of bringing down inflation, and the path to do that is not going to be pretty,” says Sarah House, a senior economist at Wells Fargo. House cites health care as one area where prices continue to defy monetary tightening.
Powell has repeatedly cited higher labor costs in service industries as one of the reasons inflation is staying sticky. Health-care employment costs rose by the most of any industry in the last quarter of 2022 and are at an all-time high—a reflection of the difficulties employers are having in attracting and retaining workers.
The US is still currently down some 260,000 nurses and residential care workers from pre-pandemic levels, a deficit that’s given rise to the term “Nursemageddon.” Burnout and retirements mean the shortage is expected to worsen in coming years, with almost 1 million nurses—about a fifth of the workforce—projected to leave the profession by 2027, according to estimates by the nonprofit National Council of State Boards of Nursing.
Not everyone buys the argument that there is a link between a tight labor market and stubborn inflation. Omair Sharif, founder of Inflation Insights LLC, says that wage demands by workers in services such as auto repair or air travel are no more of a problem for employers in those industries than, say, shortages of car parts or higher fuel prices. “Labor costs are clearly important, but in general higher costs across the structure of each business are just as important, if not more important, to the rise we saw in inflation last year,” he says.
A recent analysis by Employ America, a group that says a tight labor market should be the end goal of monetary and fiscal policies, found that core inflation indicators show wage growth is in fact slowing. “We are getting back to the point of where we are within the range of pre-pandemic levels of wage growth,” says Preston Mui, an economist at the group.
A closely watched gauge of wages, the quarterly employment cost index, showed signs of moderating in the final quarter of last year when it rose 1%, just below what economists had forecast. (The next ECI reading is due on April 28).
Still, a separate indicator of wage growth from the Atlanta Fed showed wages rose 6.4% in February from a year earlier, outpacing the increase in the CPI for the first time since the pandemic began. Other data show median weekly earnings of full-time wage and salary workers were 6.1% higher in the first quarter of 2023 compared with the same period last year.
An analysis of the major CPI components by economists at Nomura Holdings Inc. posited that inflation could slow faster than the market expects this year—but that the bigger challenge will come in 2024, when CPI inflation may remain above 3%. Besides wages, so-called structural factors such as constrained supplies of goods and energy, shifting production chains and geopolitical tensions are among the reasons economists cite for why inflation may stay higher for longer.
The optimistic scenario is that bigger borrowing costs ultimately subdue inflation without a recession. There are signs that the pace of hiring is cooling and that access to credit has narrowed, the Fed said in its Beige Book survey of regional business contacts, released April 19. Separate data showed unemployment benefit claims jumped to the highest level since November 2021.
Yet veteran Fed watcher Mickey Levy, who is chief economist for the US and Asia at Berenberg Capital Markets, an asset manager, cautions that prices will take longer to cool than broadly expected in part because the Fed is still playing catch up, having been late to recognize the scale of the inflation outbreak. “While I project decelerating inflation, my strong hunch is that it will be fairly sticky and not fall as much as the Fed projects,” he says.
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