The latest report from the Labor Department indicates that higher energy and housing prices contributed to an increase in overall U.S. inflation in December. This development suggests that the Federal Reserve's efforts to manage inflation and meet its 2% target may face some challenges.
In December, prices rose by 0.3% compared to November and 3.4% compared to the same period a year earlier. These gains surpassed the previous monthly increase of 0.1% and the annual inflation rate of 3.1% in November. The December figures slightly exceeded economists' expectations.
Housing costs played a significant role in the rise in prices from November to December, accounting for more than half of the overall increase. Meanwhile, energy costs, particularly electricity and gasoline, along with food prices, also contributed to the inflationary pressure.
Excluding volatile food and energy costs, core prices remained unchanged with a 0.3% month-over-month increase, matching November's figure. However, core prices increased by 3.9% compared to the previous year, which was slightly lower than the 4% gain recorded in November. Economists often focus on core prices as they provide a better indication of the potential trajectory of inflation by excluding items that frequently fluctuate.
Since reaching a 40-year high of 9.1% in mid-2022, overall inflation in the U.S. has been gradually cooling. However, the persistently elevated inflation levels help explain why many Americans express dissatisfaction with the economy, despite steady economic growth, low unemployment, and robust hiring.
This disconnect between economic indicators and public perception has puzzled economists and political analysts. One key factor contributing to this sentiment is the frustration caused by higher prices. Although the rate of inflation has been declining for the past year and a half, the lingering effects of the worst inflation experienced in four decades have soured many Americans' outlook on the economy. Prices remain 17% higher than they were before the inflation surge, and continue to rise.
Polls and economic experts point out that the gap between the actual health of the economy and public perception has never been as wide. Recent months have seen wage increases surpassing inflation, resulting in higher average take-home pay for Americans. Yet, a November poll conducted by The Associated Press-NORC Center for Public Affairs Research revealed that about three-quarters of respondents described the economy as poor, while two-thirds stated that their expenses had risen.
The Federal Reserve, which has been aggressively raising interest rates since March 2022 to mitigate the pace of price increases, aims to reduce year-on-year inflation to its 2% target level. Despite the challenges, there are reasons for optimism regarding the easing of inflationary pressures in the coming months.
The Federal Reserve Bank of New York's recent report indicates that consumers now expect inflation to be at 3% over the next year, the lowest one-year forecast since January 2021. Consumer expectations are significant indicators of future inflation, as they influence spending behavior. When people fear that prices will continue to rise, they tend to make purchases earlier, which can further fuel inflation. However, this cycle does not seem to be occurring at present.
In the most recent meeting, Fed officials discussed the inflation outlook and noted some encouraging signs. Particularly, they observed the resolution of supply chain backlogs that had previously caused parts shortages and inflationary pressures.
Many economists believe that reducing inflation from 9% to around 3% was relatively easier to achieve than reaching the Fed's 2% target might prove to be. Quincy Krosby, chief global strategist for LPL Financial, remarked that inflationary pressures are gradually decreasing but continue to be higher than anticipated, requiring more time to reach the final goal.
However, the December U.S. jobs report released last week presented some concerns for the Fed. Average hourly wages grew by 4.1% compared to the previous year, slightly higher than the 4% recorded in November. Additionally, 676,000 individuals exited the workforce, resulting in the proportion of adults either employed or seeking employment falling to 62.5%, the lowest level since February.
This situation raises potential concerns since a decrease in job seekers can make it difficult for employers to fill vacancies. Consequently, employers may feel compelled to significantly raise wages to attract potential workers, passing on the increased labor costs to customers through higher prices. Such a cycle can perpetuate inflationary pressures.
The Federal Reserve will continue to monitor these developments closely as it navigates the path towards achieving its inflation targets and maintaining a balanced economy. While progress has been made in lowering inflation, challenges persist, and striking the right balance is crucial to ensure sustained economic growth and stability.
