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There was something for both inflation optimists and pessimists in the March consumer price index (CPI) report.
For optimists: Annual inflation dropped to 5.0% in March, and will likely drop below 4% by the end of the year. Shelter prices, the biggest single component in the index, slowed their rate of increase to 0.6%, from 0.8% the previous month, and are expected to slow further. The prices of other services slowed their rate of increase a tick, to 0.4%. The price of groceries declined modestly, their first price drop in almost three years. Meat prices edged down, and egg prices have fallen 17% over the past two months. Energy prices dropped 3.5%, with the biggest decline in natural gas. The recent surge in clothing prices eased, and goods prices in general showed only a modest increase. Used car and truck prices declined for the ninth consecutive month. The large jumps in airfares and hotel rates in March are part of the normal rebound in these prices after the pandemic, and so aren’t likely to be sustained.
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For pessimists: The big drop in annual inflation was mostly due to the energy price spike of March 2022 dropping out of the calculation. (A further big drop in the energy component of inflation will likely happen in June, but again, only because of similar price jumps of a year ago that will fall out of the year-over-year calculation.) Price increases in services remain stubbornly high, as wage gains that drive up businesses’ operating costs are proving slow to moderate. This is likely the reason why price increases at restaurants have not slowed, for example. Excluding food and energy, so-called core inflation is still at 5.6% and may stay above 5% for the rest of the year. Price increases of new vehicles strengthened in March, and we expect prices of used vehicles to also jump in April. Gasoline prices are increasing in April because of oil production cuts by OPEC.
The “glass half full” report likely means that the Federal Reserve will raise its short-term interest rates by a quarter of a percentage point again on May 3, but pause after that. The persistence of inflation in the services sector will likely keep the Fed from cutting rates this year unless a recession hits.
The Fed is looking for easing in the underlying components of inflation that create month-to-month momentum. Shelter is important, too, since it’s a large part of the index, but Chair Powell has stated that he knows that slowdowns in this component “are in the pipeline,” as rental agreements come up for renewal and landlords dial back rent increases. But the Fed is concerned that if inflation comes down too slowly, then wage increases will stay strong, creating a cycle of further price increases, as businesses try to maintain their profit margins by passing higher wage costs along to customers.
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