Inflation shows no signs of abating

Data released last Friday showed US inflation unexpectedly accelerated in May, dashing hopes that a peak in price hikes was behind us. 

Inflation continued to be lifted by high food and energy prices, and the combination of the two have pushed inflation up to a new 40 year high on an annual basis, to 8.6 per cent.  On a monthly basis, Consumer Price Inflation (CPI) accelerated by 1 per cent and was significantly higher than the 0.3 per cent increase in April and above economists’ expectations of a 0.7 per cent rise.

The rise in inflation reflects not just gains in food and energy prices, but extremely broad-based increases under the surface, with core goods prices continuing to reaccelerate and core services prices also remaining strong, reflecting continued upside in travel related airfares and hotels.  The only silver lining was that the core CPI, which excludes food and energy prices, rose 6 per cent in May whereas in April it was running at a 6.2 per cent annual pace.  So, it is clear that, while the core rate of inflation is decelerating, the overall rate of inflation is still accelerating primarily due to high food and energy prices.

The release of the data is very important because it comes on the heels of this week’s meeting of the Federal Reserve.  Expectations thus far were that the Fed will pursue a series of 50 basis point rate hikes as it seeks to tighten financial conditions in order to slow demand and eventually inflation.  However, following the release of the inflation data, markets have moved very quickly to price in an even more hawkish path for Fed policy, with some risk that a 50-basis point rate hike might not be enough and that there might be some chance that the Fed could deliver a 75-basis point rate hike at some point over the summer.

As such, it would be interesting to hear from policymakers this week as to whether or not an acceleration in the pace of rate hikes is something that they see as a potential option.  But the bottom line here is the Fed’s work is far from done.  Inflation remains high, incoming data suggests that growth has moderated, but has not slowed enough to feel confident that inflation is likely to follow.  It’s going to be a difficult summer for Fed policymakers, and a difficult summer for data watchers as well, because each incremental inflation data point is likely to influence how Fed policymakers are likely  to react and what that path for rate hikes is likely to look like over the summer and the following months.

Even more complicated is the position the European Central Bank (ECB) finds itself in.  On Thursday policymakers in the region left the key interest rate unchanged at -0.5 per cent and hinted that they are going to raise rates by a quarter percentage next month and then they might raise rates even more in September.  This means that the ECB is only expected to climb out of negative rates territory at the end of September.  

At the same time, policymakers are facing the challenge of reining in inflation, which is also running above 8 per cent, without compounding the economic slowdown resulting from the war in Ukraine and the associated sanctions and embargoes imposed between the European Union and Russia.  This clearly makes the job of the ECB even more arduous, with the risk that they are already behind the curve,  and thus inflation could become entrenched.

Disclaimer: This article is brought to you by Stephen Borg, Head of Private Clients at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd and is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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