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US inflation update: A long and bumpy road

The Fed’s ‘wait and see’ approach shows no sign of wavering amid persistent services inflation and high wage growth.

Official interest rates in the United States were held at a target of 5.25 to 5.5% at last week’s Federal Open Market Committee (FOMC) meeting, marking 11 months of no change in US monetary policy settings.

That outcome was widely expected, as policymakers wait to see further evidence of disinflation before considering policy relief.

The evidence, at present, is somewhat thin. Last week also saw the release of the latest consumer price index (CPI) data for the US, which revealed that the headline CPI increased by 3.3% through the year to May 2024, a slight decline (in seasonally adjusted terms) from 3.4% through the year to April.

The profile of disinflation in the US is broadly similar to Australia’s. Price growth has softened among goods, especially those dependent on imported inputs that experienced the brunt of supply chain disruption at the start of this inflationary period. But US inflation remains too high among services, particularly in housing.

Consequently, the Federal Reserve’s ‘wait and see’ approach to interest rates shows no sign of wavering. The previous ‘dot plot’ recording FOMC members’ expectations for the interest rate target had suggested that the Fed would cut rates three times in the second half of 2024; this was revised down to just one rate cut after last week’s meeting.

Since mid-2023 the Fed’s preferred measure of inflation, the personal consumption expenditures (PCE) index, has decelerated more so than the headline CPI, but remains above the target. Over the year to April 2024, the PCE index increased by 2.7%, unchanged from March.

Chart 1: Measures of US inflation, year-to % change

Source: Bureau of Labor Statistics (CPI); Bureau of Economic Analysis (PCE)

Around one-third of the US CPI basket consists of housing costs, while housing accounts for closer to one-sixth of the PCE index. As housing costs emerge as one of the most persistent areas of price growth, the two indexes have diverged, and disinflation is more evident in the PCE index than the CPI.

Weights in the PCE index are also updated monthly, as opposed to annually for the CPI. The PCE index is therefore a more timely indicator of inflation, as consumers switch to cheaper substitutes to avoid the full brunt of higher prices.

In anticipation of PCE inflation slowing further, financial markets are pricing in two rate cuts in the second half of 2024 – out of kilter with the single cut implied by the FOMC members’ dot plot.

Mixed US labour market data has done little to settle the way forward. The number of payroll jobs added in May significantly exceeded expectations and hiring was broad among industries, but this came alongside an increase in the unemployment rate to 4% after 27 consecutive months with a 3-handle. The participation rate also declined in May, while wage growth continues to exceed 4% on a year-on-year basis (above the 3 to 3.5% historically consistent with the 2% inflation target).

Persistent services inflation, high wage growth, and a resilient labour market do not form a strong evidence base for easing monetary policy any time soon. But there are sufficient signs of a softening outlook to caution against any further rate increases to attempt to bring inflation more quickly. Amid mixed signals, the Fed’s ‘wait and see’ approach is prudent and unlikely to change over the next few months.

This newsletter was distributed on 18 June 2024. For any questions/comments on this week's newsletter, please contact our authors:

This blog was co-authored by Aiden Depiazzi, Associate Director at Deloitte Access Economics

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