The Federal Reserve is facing some remaining hurdles on its journey to curb inflation, referred to as the “last mile” effort. February’s consumer price index (CPI) report serves as a roadmap for these challenges, highlighting persistent issues such as soaring housing costs, continuous upticks in service prices, and the persistent wage pressures stemming from a tight labor market.
All these factors are crucial for the central bank to attain its 2% inflation target.
Gus Faucher, chief economist at PNC Financial Services, remarked, “This is telling us the same story that we had before, which is that inflation is gradually slowing, but it’s going to take some more time for inflation to get back to the 2% objective.”
The CPI, a comprehensive gauge of prices across the vast U.S. economy, revealed a 3.2% year-over-year increase, slightly surpassing the Dow Jones estimate and January’s figures. Excluding volatile food and energy prices, the inflation rate stood at 3.8%, also exceeding expectations.
Although these figures are notably lower than the peak levels witnessed in the summer of 2022—marking the highest levels in over four decades—they still surpass the Fed’s targets. Consequently, inflation is complicating the central bank’s plans to potentially lower interest rates later this year.
Despite their daunting nature, the Fed faces three significant obstacles, each showing signs of progress.
Firstly, policymakers anticipate that unique factors influencing shelter costs will reverse course later in the year, alleviating pressures on housing expenses, which comprise one-third of the CPI weight.
Additionally, core services costs, excluding housing services, known as “super core” inflation, remain elevated, but the pace of increase has slowed to 0.5%.
Moreover, wage pressures, while debatable in their impact on inflation, seem to be moderating.
Although average hourly earnings rose in February, inflation-adjusted pay decreased by 0.4% for the month and only increased by 1.1% year-over-year, according to the Bureau of Labor Statistics.
The challenge ahead lies in the limited efficacy of tight monetary policy, characterized by high-interest rates and a reduction in the Fed’s balance sheet, in addressing the current economic situation.
According to Sung Won Sohn, a finance professor at Loyola Marymount University and chief economist at SS Economics, the central bank’s “last mile” problem stems from inflation in service prices, driven partly by the tight labor market in sectors like healthcare, leisure, hospitality, and construction.
This has escalated costs for various services, from dining out to personal care and home repair. Such inflation, often termed “cost-push inflation,” may not respond straightforwardly to changes in interest rates.
The current inflationary surge stands in stark contrast to the post-financial crisis period, where inflation remained largely subdued from the end of the crisis in 2009 until the onset of the COVID-19 pandemic in March 2020.
A decade ago, headline CPI inflation was at 1.1% and core inflation at 1.6%, reflecting the tight range within which inflation operated during that period.
Back then, annual shelter inflation stood at 2.6%, compared to the current 5.7%, while services excluding energy were at 2.2%, contrasting with the current 5.2%. Average hourly earnings also saw slower growth at 2.3%, compared to the current 4.3%.
Gus Faucher from PNC notes that wage growth was considerably slower during that time, and the labor market wasn’t as constrained. However, he acknowledges that the current economy is experiencing post-pandemic effects, including tight housing and labor markets.
Despite these challenges, Faucher believes the Fed will eventually rein in inflation, whether by adopting the data-dependent approach it advocates presently or by tightening policy further, albeit reluctantly.
JPMorgan Chase CEO Jamie Dimon has cautioned the Fed to proceed cautiously with rate cuts, warning that a recession this year is a possibility.
Faucher remains confident in the Fed’s commitment to achieving its 2% inflation target. However, he acknowledges the risks involved, emphasizing the importance of achieving a slowdown in inflation without causing a recession.
If inflation fails to abate over the next six months and the Fed is compelled to maintain or even raise the fed funds rate, the risk of recession increases.
