15 Feb 5 Things You Need to Know about Inflation!
Inflation at a 40-year High!
The U.S. Labor Department announced that the Consumer Price Index jumped by 7.5% year-on-year, marking the biggest annual increase in inflation since February 1982. The CPI rose by 0.6% in January, with core CPI increasing by 0.6%, a rise of 6.0% year-on-year. The price increases were driven by rising costs of living, be it rent, electricity, food and supply and worker shortages affecting industry, federal aid and strong consumer spending.
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Consumer sentiment has also hit a decade low as there is increasing pressure on personal finances. The consumer sentiment index by the University of Michigan slid to 61.7, from 67.2 in January, the lowest since October 2011. The drop reflects the sentiments of investors too, who believe that the economy is slowing down, a situation further aggravated by the threat of a war looming between Ukraine-Russia.
Imminent Interest Rate-Hike
The soaring inflation is sending alarm bells ringing with the Federal Reserve likely to increase interest rates by 50 basis points in March, which will increase borrowing rates across the economy that will in turn have an impact on mortgages, credit cards, auto loans and corporate credit. The tightening measures, though necessary, may trigger another recession.
In January 2022, the Federal Reserve signalled that it will initiate a series of interest-rate hikes as a measure to arrest inflation that was boosted by policies introduced during the pandemic to revive the economy. The measures include raising the benchmark rate from Zero, to prevent escalating prices. The Federal Reserve Chair Jerome Powell is confident that the higher rates will be managed effectively, to not only promote growth and keep unemployment levels in check, but also without any significant impact on the labor market.
The steps aim at reigning in the economic growth and the resultant inflation, while preventing it from having an adverse impact on household budgets. Supply-chain and labour shortages are taking longer to resolve than anticipated, while the CPI has far surpassed the Fed’s inflation target of 2%.
Pandemic-Era Measures Fuelling Inflation
The inflation is expected to reach 5% over the next year, the highest since 2018, with most of the reasons contributing to the price rises still persisting. While there is an increase in wage rates, at a much faster rate than the previous 20 years, inflation has almost nullified these raises with Americans struggling to afford necessities like food, rent, gas among others. Companies are offering wage hikes and higher compensation to attract and retain talent among workforce scarcity. The state unemployment benefits decreased to 223,000 for the week-ended Feb 5, as against a three-month high in mid-January.
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The cost of food consumed at home increased by 1%, while food prices grew by 0.9%, with steep increases in prices of dairy, cereal, bakery products, fruits and vegetables. Cheaper gasoline and natural gas were offset by a 4.2% increase in electricity prices. Rents increased by 0.5%, the largest since May 2001, accompanied by the lowest rental vacancy rates since 1984.
There were strong gains in airline fares, household furnishings, apparels and used cars and trucks. Healthcare costs also saw an upward revision by 0.7%. The only consolation was that new motor vehicle prices remained flat.
Consumer Price Index Re-weighted
The consumer price index was re-weighted from January onwards, based on expenditure data from 2019-2020, assigning more weight to goods than services, which may account for some of the increases in the CPI. Furthermore, the COVID-19 pandemic has caused a shift in spending patterns, with goods overtaking services. Pandemic relief from the government fuelled spending, but supply and capacity constraints ended up putting more pressure, as worker shortages due to pandemic slowed down manufacturing activities across industries.
Impact on Stock Markets, Bonds and Equities
The announcement was followed by a fall in equities and bonds, with U.S. Treasury prices decreasing, for instance the yield on the 10-year note reached 2%, the lowest since August 2019. There are concerns about immediate rate hike before March, however, the Fed has clarified that it will complete the bond purchases in March and will work on reducing their $9 trillion balance sheet.
The Fed is likely to raise the rates by 25 basis points, 5-7 times in 2022, as it seeks to strike a balance between tackling inflation, while promoting economic activity. The inflation could ease in the coming months, with the Omicron-led coronavirus infections waning and supply constraints slowly easing. Moreover, as the economy bounces back to normalcy, the spending patterns are likely to shift again towards services, which could lower inflation rates.
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