Press "Enter" to skip to content

The Federal Reserve Is Stuck Between Inflation, Interest Rates, And A Breaking Economy

U.S. consumer price growth eased somewhat from January to February, but it still points to a high inflation rate, which poses a problem for the Federal Reserve at a sensitive time for the financial system. 

Prices increased 0.4% last month, the government said on Tuesday, slightly less than January’s 0.5% rise. However, after excluding volatile food and energy costs, the so-called headline prices increased 0.5% in February, just above the 0.4% gain seen in January. 

The Fed pays special attention to core measures as a measure of potential inflationary pressures. Even with prices rising at much higher rates than the Fed wants, some economists are expecting the central bank to pause a run of rate increases at its meeting next week.

With the failures of two major banks since Friday raising concerns about other regional banks, the Fed might for now be focused more on building trust in the financial system than its longer-term quest to curb inflation. 

That is a dramatic change from just one week ago, when Chairman Jerome Powell suggested before a Senate committee that the Fed might increase the benchmark rate by a significant half-point at a meeting on March 21-22, unless inflation cooled. 

When the Fed increases its key interest rates, that usually leads to higher rates for mortgages, car loans, credit cards, and many commercial loans. Measured relative to prices one year ago, inflation has been falling for eight months.

In February, consumer prices were up 6% compared with 12 months ago, less than the 6.4% increase compared with January, and far less than the last spike in June, which was 9.1%. Yet that remains far above the Fed’s goal of 2% annual inflation. Core prices rose 5.5% in February compared with 12 months earlier, slightly below the 5.6% pace seen in January.

Nearly three-quarters of the increase in prices in the past month was due to rising housing costs. But most economists expect that rising rent costs will be slower in coming months, as more multifamily units are built and more new leases are signed at lower prices. Such a drop may slow inflation even further. Prices continued to rise last month in the vast services sector of the economy.

Restaurant prices rose 0.6% from January to February. Auto insurance rose 0.9%, and hotels were up an impressive 2.3%. Air travel, after being on the decline for months, skyrocketed 6.4% just in February, a 27% increase over the same period last year.

The Federal Reserve has been heavily focused on services, which are highly reliant on workers, and where rising prices are driven in large part by higher wages. Labor shortages in many service industries are driving up wages.

Clothing costs rose by 0.8% last month. New vehicle prices rose only 0.2%, a second consecutive month. Used car prices fell 2.8%, their eighth consecutive month of decline.

Consumers are getting some relief in grocery stores. Food prices rose 0.3% in February, their lowest monthly increase in almost two years, although still up over 10% year-over-year. The price of eggs, which had skyrocketed 55% compared with the same time last year, actually fell 6.7% just in February.

“These data support a quarter-point rate hike” at the Fed’s meeting next week,” Rubeela Farooqi, chief U.S. economist at High Frequency Economics, said in a research note. “The decision ultimately will depend not only on the economic data but also financial stability concerns, which could keep the Fed on the sidelines next week.”

Nationwide, persistently high inflation is still straining many consumers. Mani Bhushan, who owns four Taco Ocho restaurants in the Dallas area, has been struggling to keep up with sharply rising prices of eggs, chicken, flour and black beans. He has also had to increase wages about 30% in order to attract and retain the workers he needs. To pay for his higher costs, Bhushan raised some prices last week, after doing so four months ago.

“You get hit from every side,” he said. “We don’t make much profit anymore.”

He plans to increase prices again in May, if the price of food does not come down any more. For the Fed, it is unclear if it will continue raising rates in the upcoming session in order to fight inflation. 

Jan Hatzius, a senior economist at Goldman Sachs, said Goldman now believes the Fed’s policymakers will stop raising rates next week. Goldman had earlier predicted a quarter-point hike. In his note to clients, Mr. Hazius noted the Federal Reserve appears even more focused at this time on keeping the banking sector and financial markets quiet than it is on fighting inflation.

“We would be surprised if, just one week after going to great lengths to support financial stability, policymakers risked undermining their efforts by raising interest rates again,” Hatzius wrote in a separate note Monday.

If the Fed really does suspend rate increases this month, Hatzius predicted, it is likely to resume them at the next meeting, in May. Ultimately, she still expected the Fed to increase its headline rate, which influences many consumer and commercial loans, to around 5.4% this year, from its current 4.6%. The Fed could receive some inadvertent assistance with its fight against inflation as a result of the effects of the failures of Silicon Valley banks and Signature Bank in New York. In response, many smaller- to mid-sized banks could scale back lending in order to strengthen their balance sheets. A slower lending rate may help to cool the economy and reduce inflation.

The following day, Powell testified before a House panel, warning that there was not yet a final determination on what the Fed would do at its March meeting.

Despite this, on Friday, the administration reported employers added a healthy 311,000 jobs last month.

That is a potentially strong indication that inflation is continuing its march upward, leading to predictions that a one-half-point increase will occur next week when the Federal Reserve meets. Later in the day, however, the failure of the Silicon Valley bank sent a whole new set of worries into the Fed.

0 0 votes
Article Rating
Notify of
Inline Feedbacks
View all comments
Would love your thoughts, please comment.x