US consumer prices surge above expectations in June – transitory rise or inflation is unleashed?
What does the latest US CPI report tell us?
The US consumer prices accelerated more than expected in June, having the highest rise since July 2008, as the economic recovery gathers momentum.
The consumer price index rose by 0.9% in June from 0.6% in May, beating the forecast of 0.5% increase, while the inflation in the twelve months through June jumped 5.4% - the highest in thirteen years - after rising 5.0% in May, overshooting the 4.9% forecast.
The so-called core CPI which excludes volatile food and energy components, rose by 4.5% on a year-on-year basis from the 3.8% increase in May, making the biggest increase since November 1991.
Strong rebound in the costs of travel-related services and persisting supply constraints were the main drivers of inflation last month, as the low interest rates and the nearly $6 trillion that the government has pumped into the economy since the pandemic started in the United States, fueled the demand and strained the supply chain that lifted prices across the economy.
Although the inflation in the US has likely peaked, it is expected to remain elevated through the second half of 2021 and a part of 2022, as demand for travel and accommodation services continues to rise and prices for most of these services are still below pre-pandemic levels.
The US Federal Reserve has repeatedly stated that the higher inflation will be transitory, and the central bank could tolerate higher consumer prices for some time, to offset years in which inflation stayed well below its 2% target.
On the other side, a number of policymakers see inflation risks shifted to the upside and the Fed needs to be prepared to act if those risks materialize, as many fear that the mix of monetary and stimulus measures has gone too far and could spark uncontrollable inflation.
The fresh spread of the Covid-19 virus with the Delta variant in the US threatens to slow the economic recovery if new cases continue to rise quickly, but new restrictive measures are unnecessary to cool down the inflation.
With current inflation being well above the 2% target, the main question for the Federal Open Market Committee will be where the consumer prices will stand in six months.
The US policymakers reiterated that the central bank would use all available tools to guide the inflation back down but remain convinced that the recent price hikes are transitory and associated with the post-pandemic reopening of the economy.
The Federal Reserve Chairman Jerome Powell, in his testimony to the US House of Representatives, repeated this view, expressing expectations that inflation pressures will fade and that the central bank should stay focused on getting back to work as many people as possible, as the US labor market is still short around 7.5 million jobs, compared to the pre-pandemic period.
Powell said that the current high inflation readings are for a small group of goods and services directly tied to the reopening of the economy, seeing no need to rush with the start of changing the policy from the ultra-loose mode, introduced during the crisis, towards a post-pandemic gradual tightening.
The central bank is expected to continue to closely watch the situation and to pump money into the economy until the Fed's second key requirement for starting to tighten the policy - substantial further progress in the labor market - is reached, with interest rates expected to stay near zero until at least 2023.
But the recent surge in consumer prices has divided the US politicians and lawmakers, with Democrats urging the Fed not to slow the recovery with too-early policy action, while Republicans worry that the central bank's response to the surging inflation might be too slow.
Republican representatives point to a strong rise in prices that already hurt businesses and families and sideline the Fed's description for price increases is temporary. They also questioned Powell about a new framework that aims to encourage higher employment by keeping inflation to run moderately above the Fed's 2% target for some time, as higher inflation starts to bite, and it is unclear how long that 'some time' will last.
The Fed is also pressured by signals from several major central banks that started their policy tightening due to a strong rise in inflation earlier than expected.
The main question is whether the current
surge in prices is temporary, as US policymakers see it, and the reduction of
the financial stimulus and an increase of interest rates can wait, or the sharp
rise signals that inflation is getting off its leash and the US central bank
might be late to react on such a scenario.