Last updated: 08:11 / Thursday, 12 May 2022
Article by ING

US inflation has peaked, but it will be a long slow descent

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US inflation has slowed marginally in April thanks to a fall in used car prices and gasoline. Fed rate hikes will bring demand into better balance with supply, but in the absence of major improvements in supply chains, labour shortages and geopolitical tensions the descent back to the 2% target will be slow, according to an article by ING Bank.

We think that March 2022 will have marked the peak for annual inflation. Mannheim used car auction prices are down 6.4% over the past three months so used vehicle prices should fall further and they have quite a heavy weight of 4.1% of the total basket of goods and services within CPI. The shift in consumer demand from goods, whose availability has been significantly impacted by supply chain issues, towards services should also contribute to a gradual moderation in the rate of inflation. Nonetheless, we remain nervous about the impact from gasoline and the growing price pressures within services, says ING's expert, James Knightley.

Moreover, substantial declines in the annual rate of inflation are unlikely to materialise until there are significant improvements in geopolitical tensions (that would get energy prices lower), supply chain strains and labour market shortages.

Unfortunately, there is little sign of any of this happening anytime soon – The Russia-Ukraine conflict shows no end in sight, Chinese lockdowns will continue to impact the global economy while last Friday’s jobs report showed a decline in the labour force participation rate leaving the economy with 1.9 job vacancies for every unemployed person in America.

At the moment consumer demand is firm and businesses have pricing power, meaning that they can pass higher costs onto their customers. This was highlighted by yesterday’s National Federation of Independent Businesses survey reporting that a net 70% of small businesses raised prices over the past three months, with a net 46% expecting to raise prices further. We haven’t seen this sort of pricing power for the small business sector before and we doubt it is any weaker for larger firms.

Fed has a lot more work to do

This situation intensifies the pressure on the Fed to hike interest rates. The central bank wants to take some of the heat out of the economy and bring demand back into better balance with the supply capacity of the US economy. This potentially means aggressive rate hikes and the risks of a marked slowdown/recession.

This message was re-affirmed by several officials over the past couple of days and we look for 50bp rate hikes at the upcoming June, July and September FOMC meetings. With the Fed running down its balance sheet we expect the Fed to revert back to 25bp from November onwards with the target rate peaking at 3.25% in early 2023.

Even with this Fed action and hopefully some improvements in the supply side story we have doubts that CPI will get back to 2% target before the end of 2023.

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