US consumer prices surge at fastest rate in forty years

If you’ve noticed your dollars don’t seem to have the same purchasing punch as they did a year ago, there’s a very good reason for that.

Consumer price inflation in the United States rose at an annual rate of 7.5 percent in January, the Bureau of Labor Statics said on Thursday. That is the fastest pace since July 1982.

On a monthly basis, the Consumer Price Index (CPI) – which measures price changes in a basket of goods and services –  increased 0.6 percent in January compared with the previous month.

Surging prices for groceries, electricity, and rent led the charge higher, with the food index rising 0.9 percent in January, after increasing 0.5 percent in December.

The energy index also rose 0.9 percent in January compared with the previous month, as soaring electricity prices were partially offset by falling prices for gasoline and natural gas.

The so-called “core” index, which strips out volatile food and energy, rose 0.6 percent in January – the same rise as December.

January marked the seventh time in the past 10 months that the core index rose at least 0.5 percent.

Inflation is placing an increasingly onerous burden on American households but is especially tough on low-income ones because it eats up a larger share of their financial resources.

Economists over at Moody’s Analytics estimate that annual inflation is costing the average US household $250 a month based on December’s CPI figures.  Americans aged 35 to 54 are spending $303 – $305 more a month, according to Moody’s, while pensioners aged 65 and older, are spending $194 a month.

To place that burden and the financial fragility it feeds into perspective – some 36 percent of Americans do not have enough cash or cash equivalents to cover a $400 emergency expense, such as a car repair or medical bill, according to the US Federal Reserve.

Cue the Fed

Inflation has become the main point of concern for Fed officials. While a little bit of inflation is good for an economy, too much of it can become deeply damaging, especially if consumers start to expect that prices will continue to rise sharply.

When those inflation expectations become unanchored, price pressures can spiral out of control, forcing the Fed to increase interest rates so aggressively that it derails the nation’s economic recovery.

That “hard landing” scenario, is something the Fed – and pretty much everyone for that matter – would like to avoid.  And indeed, since December, policymakers at the US central bank have been signalling their intention to raise interest rates at least three times this year. At the conclusion of its policy-setting meeting last month, Fed chief Jerome Powell told reporters the US central bank will likely start raising interest rates in March.

That messaging helps anchor expectations and prepare the market for the end of cheap money policies that helped the economy – and specifically the labour market – climb out of 2020’s pandemic hole.

Indeed, the economy and the jobs market have been staging such a strong recovery since then, that both are feeding inflation.

Surging demand, especially for goods, has triggered supply chain snarls and shortages, raising costs for businesses.  And while the labour market has yet to recover all the jobs lost to 2020 lockdowns, the shape of it has changed dramatically during the pandemic.

Millions of workers have decided to either retire early, open their own businesses or stay on the sidelines due to fear of contracting COVID.  Far from a shortage of jobs, the US labour market is awash in a near-record number of them.

That imbalance between job openings and job seekers has landed US workers in their best bargaining position in decades. And indeed, businesses are offering better pay and benefits packages to lure them.

As a result, average hourly wages are rising. They climbed 5.7 percent in December compared with a year ago. But those fatter paycheques are not keeping pace with inflation. Moreover, they feed inflation because it’s another input cost increase businesses are passing on to consumers by charging them more.

Unleashing the hawk

The Fed has a tough balancing act ahead of it.  If it becomes too “hawkish” and tightens rates too sharply or too often, it could slam the brakes on economic growth. But if it is too “dovish” and fails to tame price pressures effectively, that’s harmful too.

Many economists see the Fed channelling a hawk as its spirit animal this year, rather than a dove.

At Oxford Economics, for example, chief US financial economist Kathy Bostjancic published a note in the wake of Thursday’s CPI numbers saying: “We had previously expected at least a total of 100bps of rate increases in 2022, but we would now see at least 125bps with the rate hikes front-loaded to the first half of this year.”

FYI: 125 basis points is an increase of one and a quarter percentage points.

Consumers feel higher interest rates in all sorts of ways, from sharper rates on credit cards to higher mortgage rates if they’re in an adjustable product or looking to buy a home. Businesses feel it too because it raises their cost of credit.

Moreover, because the US is the world’s largest economy and the US dollar is the global reserve currency when the Fed increases rates, it ripples throughout the globe.

Countries that issued debt denominated in dollars face higher repayment costs. And investors who chase higher returns in emerging markets when US interest rates are low tend to pull that money out of those markets when the Fed starts to taper easy money policies.

That can force emerging markets to raise their interest rates to keep their own currencies from losing value against the dollar – but there’s a sting in the tail because it can cool their economic recoveries.

Such is the nature of the global economy.

So when Americans are paying more at the pumps, and to keep food on the table and a roof over their heads, it’s not just a problem for them. It can quickly become the world’s problem – especially if the Fed gets it wrong.