How inflation spread across different sectors, making it harder to tame

WASHINGTON (AP) – What is driving inflation so high? The answer, it seems, is almost everything.

As the economy surged out of the pandemic recession two years ago, supply chain problems and parts shortages drove up the cost of factory goods. Then it was a surge in consumer spending fueled by government stimulus controls. Then Russia’s invasion of Ukraine cut off gas and food supplies and sent those prices skyrocketing.

Since March, the Federal Reserve has raised interest rates aggressively to try to cool spikes in prices. Little progress has been made so far. Thursday’s September consumer price report came in hotter-than-expected, although some previously big drivers of inflation — gasoline prices, used cars — fell for a third straight month.

CLOCK: Despite the Federal Reserve’s efforts to stabilize costs, inflation remains stubbornly high

Consumer prices, excluding fluctuating food and energy costs, have soared 6.6% year-on-year – the fastest such pace in four decades. Headline inflation eased somewhat, mainly due to cheaper gas. But higher priced food, medical supplies and housing pointed to mounting price pressures across the economy.

High inflation has now spread well beyond material goods to the country’s vast service sector, which includes everything from dental care and apartment rentals to car repairs and hotel rates. Widening inflation makes it harder to tame. Thursday’s report underscored that the Fed may need to raise its short-term interest rate higher than expected and hold it there longer to contain inflation.

Such a move would mean even higher lending rates for consumers and businesses. It could also cause recessions in both the U.S. and global economy, international finance officials warn. Higher US interest rates are encouraging investors to withdraw money from foreign markets and invest it in US assets for higher yields, a shift that could disrupt economies overseas.

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Here’s what’s driving persistent inflation and what it means:

The spending is still holding up – for some

Consumers overall are still managing to spend more, although average wage increases have not kept pace with inflation over the past year. Many companies, particularly larger companies, have taken advantage of rising wages and increased consumer savings from government stimulus controls to raise prices.

PepsiCo, for example, said Wednesday that while the volume of purchases fell 1% in the third quarter of the year, it managed to raise prices 17% without losing customers.

“We obviously ended the third quarter with consumers still very healthy relative to our specialty categories,” the company’s chief financial officer, Hugh Johnston, told investors.

CONTINUE READING: Retail sales were flat in September as rents and food prices rise

Still, falling wages (adjusted for inflation) could stifle demand for many Americans and help force companies to cut prices.

There are already signs that some Americans, especially low-income families, are wary of inflated prices. Sales of used cars fell in the summer. A major auto dealership, the CarMax chain, blamed “vehicle affordability issues stemming from widespread inflationary pressures as well as rising interest rates.”

At the same time, Jonathan Smoke, chief economist at Cox Automotive, said many higher-income consumers have entered the used-car market and offset at least some of the loss suffered by previous buyers.

“We’re seeing an increase in higher-income households buying used vehicles,” Smoke said. “The profile of those who buy used products is an extremely high-profile customer type.”

Service inflation takes over

Rising prices can often prompt consumers to reallocate their spending to other things rather than cut back altogether. For example, Americans are currently shifting more of their spending from physical goods to services. And that shift is reflected in the categories where prices are rising.

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“Most people in America spend pretty much their entire budget anyway,” says Eric Swanson, an economics professor at the University of California, Irvine. “So the money is spent, it’s just a question of what it’s spent on.”

In September, the price of an important service – restaurant meals – rose by 8.5% year-on-year. It was the largest such increase in 41 years. Likewise, Delta and American Airlines are reporting strong revenue growth as more Americans are willing to spend money on travel.

CLOCK: Will the increase in Social Security benefits be enough to offset inflation?

Yet restaurants, airlines and hotels still have far fewer workers than they did before the pandemic. With demand healthy, companies in these industries have been forced to offer hefty wage increases to attract or retain workers. These increases are then often passed on to consumers in the form of higher prices – a cycle that fuels inflation.

Many other services are also reporting sharp price increases, including health care, auto insurance, veterinary services and dental visits. Eye care and eyewear rose 3.2% from August to September, the fastest increase for this category on record.

Home prices are defying the Fed

The Fed’s rate hikes have resulted in significantly higher mortgage rates, which has contributed to a 20% year-over-year decline in home sales. In fact, once-hot home prices fell on a monthly basis in July, according to the latest data from the S&P Case-Shiller Home Price Index.

CONTINUE READING: High mortgage rates and prices deter buyers and cool the housing market

Apartment rental costs are also starting to slow, according to real-time data from ApartmentList and Zillow.

But a key measure of housing costs rose 0.8% from August to September in Thursday’s inflation report. It was the largest monthly increase in 32 years. The discrepancy is because the government’s rent meter works with a significant lag: it tracks all rent payments — not just those for new leases — and most of them don’t change from month to month. Economists say it could take a year or more for falls in new rentals to show through on government data.

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Will the Fed trigger a recession?

This is the greatest fear towering over the economy. Chair Jerome Powell and other Fed officials have said they will base their policy only on changes in the government’s inflation data, rather than reacting to data from other sources.

But this poses a risky challenge for the central bank: will it raise rates further or leave them high if forward-looking data suggest rental costs are falling?

For now, the Fed is poised to sidestep and continue raising lending rates. According to the minutes of their last meeting in September, “Policymakers stressed that the cost of doing too little to lower inflation is likely to outweigh the cost of doing too much”.

Fed poised to weaken economy for ‘a few years’

At their last meeting in late September, Fed officials warned that their rate hikes would likely slow the economy for an extended period, with growth “being below trend for this year and years to come” and unemployment likely to rise.

CONTINUE READING: Federal Reserve Chair Jerome Powell says inflation struggle could cause recession

Among central bank officials, Loretta Mester, President of the Federal Reserve Bank of Cleveland, made one of the harshest remarks this week when she suggested that “it will be a couple of years before inflation returns to the Fed’s 2% target.” .

“We cannot say that inflation has already peaked,” Mester said.