Overnight, March’s consumer price index (CPI) report showed US inflation starting to pick up as the economy recovers from the pandemic.
Core inflation - excluding volatile food and energy costs - increased by 0.3%MoM. This pushed the year-on-year change in core consumer prices up from 1.3% in February to 1.6% in March as the chart shows.
Inflation rose as the re-opening of the economy led to higher airfares and hotel accommodation costs. Goods prices also increased owing to strong demand and because of supply chain disruptions.
Furthermore, consumer prices were also supported by firmer ‘sheltering costs’ with the rebound in America’s labour market this year stopping tenancy rates from falling further. The chart shows that the slide in ‘owners’ equivalent rent’ - an important component of overall consumer prices in the US - caused by the pandemic appears to have stopped now.
March’s CPI report also marks the beginning of three months of inflation data affected by ‘base effects.’ Over the next few months, changes in consumer prices will appear exaggeratedly high compared to the start of the pandemic last year when prices fell during the first round of lockdowns in the spring of 2020.
US inflation
Source: Bank of Singapore, Bloomberg
Thus, the combination of economic re-opening and ‘base effects’ in the inflation data is set to result in core inflation rising further to around 2.5% in April and May.
The Federal Reserve targets a separate measure of inflation based on personal consumption expenditure prices (PCE). Core PCE inflation is also likely to rise over the next few months for the same reasons. March’s PCE data due at the end of this month is set to increase from 1.4% to 1.8% while April’s and May’s reports are similarly set to peak around 2.5% this year on base effects.
This year’s upcoming surge in inflation over the next months is thus set to exceed the Federal Reserve’s 2% target. But the central bank will not start lifting its fed funds interest rate from 0.00-0.25% in 2021 because inflation is likely to ease again in the second half of the year back towards the Fed’s 2% goal once base effects wane from June onwards.
Significantly, Inflation expectations continue to be anchored around the central bank’s 2% target while the US economy will still need several quarters to recover all of the 22 million jobs lost at start of the pandemic last year. Therefore, the Fed is set to look through any temporary rise in inflation above its 2% goal this year and keep interest rates unchanged in 2021 to the benefit of risk assets. We expect the central bank will not start raising interest rates until as late as 2024.
