Where is inflation going?
Base effect and drivers. To understand inflation we have to look at both.
Base Effect:
Inflation ran high in the second half of 2021 and the most significant growth in CPI was concentrated in the first half of 2022. In the second half of 2022, the CPI remained rather stable and has been falling.
Drivers:
Disinflation has been driven mainly by energy and healthcare. Now, healthcare costs are on the rise. In 2024, medical costs are predicted to increase by 7%, according to a recent report from consulting firm PwC. Healthcare is 22% of PCE price index (PCEPI) or the second largest component after housing.
Energy prices have been flat for the last few months. Later next winter Europe and Asia might start running low on the cheap Russian oil and natural gas they put in storage. Storage is relatively high and should maintain prices until winter. After that, all bets are off. Everything from food to goods will go up if energy prices soar and it’s not like we have OPEC opening the spigot or more supply coming online.
Even the Fed is not so sure that inflation will fall later this year or next year. One model even shows core inflation falls slightly and climbs back up near 5% and remains high over the next 12 months.
With wages still up (6% growth), job numbers still strong, and boomers still spending the potential of higher inflation and higher rates after the base effect runs out is real. The Fed is not 100% sure and the cost of being wrong on inflation up or down is catastrophic but the risk is greater if inflation goes up versus goes down.
Fed hikes are more likely until we see what happens after the winter.
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