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Why Inflation May Seem to Be Easing but Remains a Significant Problem

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Although the Federal Reserve appears to be closing in on its inflation target, the ongoing high cost of goods and services continues to strain the U.S. economy. While recent data shows inflation slowing, the effects of price increases are still evident, causing challenges for individuals, businesses, and policymakers.

Some economists, such as those at Goldman Sachs, predict that upcoming reports may indicate the inflation rate approaching the Fed’s 2% target. However, inflation is a complex issue, not easily encapsulated by a single metric. By some measures, inflation remains uncomfortably high for many Americans and even some Fed officials. San Francisco Fed President Mary Daly recently acknowledged the progress in lowering inflation but warned against complacency, emphasizing that vigilance is still necessary.

Inflation is far from over. Daly’s anecdote about a local resident asking her if the Fed had “declared victory” highlights the public’s concern. The central bank’s recent decision to cut interest rates was aimed at adjusting policy in response to inflation, which has come down from its 2022 peak. Yet, many Americans remain skeptical, as high prices linger in various sectors.

There are two ways to assess inflation: the 12-month inflation rate, which receives most of the attention, and the cumulative impact that inflation has had over the past three years. The Consumer Price Index (CPI), one of the most widely followed indicators, has shown a dramatic improvement, with inflation at 2.4% in September, down from a peak of 9.1% in June 2022. However, other indicators show a less promising picture. For example, the Fed’s preferred measure, the Personal Consumption Expenditures (PCE) price index, is still slightly above the 2% target, according to projections.

Inflation first surpassed the Fed’s 2% goal in March 2021 and was initially considered a “transitory” phenomenon linked to pandemic-related disruptions. Yet, over the past two years, prices have skyrocketed across many sectors. Since the start of the inflation surge, the all-items CPI has risen 18.8%, food prices have jumped 22%, and the cost of everyday necessities like eggs and gasoline have climbed sharply. Housing prices, too, have surged, with the median home price increasing 16% since early 2021.

Furthermore, “sticky” prices—those less likely to change frequently, such as rents, insurance, and medical costs—are still rising at a 4% rate, even as more flexible items like food and gas show signs of easing. This divergence between different inflation measures highlights the complexity of the issue.

Core inflation, which excludes food and energy, continues to be a concern as well. In September, core CPI inflation stood at 3.3%, while the core PCE index was 2.7% in August. These figures suggest that despite some improvement, underlying inflation pressures remain.

Consumer spending has remained strong despite high prices. In the second quarter of 2024, consumer spending reached nearly $20 trillion on an annualized basis, though the pace of spending is beginning to slow. Borrowing has also increased significantly as households have taken on more debt to cope with rising costs. Household debt rose 19% since early 2021, with delinquencies on the rise, though still below historical averages.

Small businesses are also feeling the strain. Many have turned to credit cards to manage cash flow, with small business credit card balances increasing by more than 20% compared to pre-pandemic levels. Inflation remains the top concern for many business owners, as seen in surveys conducted by organizations like the National Federation of Independent Business.

As the Fed prepares for its next policy meeting in November, it faces a difficult choice. While interest rates have been reduced, financial markets are reacting unpredictably, with bond yields rising and mortgage rates climbing despite the Fed’s easing efforts. Some economists argue that the Fed should hold off on further rate cuts until it can better assess the current inflationary environment.

In the end, the public remains uncertain about whether the Fed has truly tamed inflation. As Daly noted, while progress is being made, the journey toward stabilizing prices and achieving lasting economic relief is far from over.

 

UK Inflation Falls Sharply to 1.7%, Below Bank of England’s Target for First Time in Over Three Years

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Inflation in the United Kingdom dropped sharply to 1.7% in September, marking the first time since April 2021 that inflation has fallen below the Bank of England’s (BOE) 2% target. The Office for National Statistics (ONS) announced the drop on Wednesday, surprising markets as economists had expected a higher inflation rate of 1.9% for the month. The fall from 2.2% in August to 1.7% in September has now intensified speculation about a potential rate cut by the BOE in November.

Core and Services Inflation Drop

Core inflation, which excludes volatile components like energy, food, alcohol, and tobacco, also fell from 3.6% in August to 3.2% in September, lower than the 3.4% forecast. Meanwhile, inflation in the services sector, a key driver of the UK economy, eased to 4.9% from 5.6%, its lowest rate since May 2022.

These declines in core and services inflation are crucial for the BOE as it assesses whether to adjust interest rates further. A reduction in services inflation, in particular, suggests that underlying price pressures are starting to ease, providing the BOE with more flexibility.

Rate Cuts Anticipated

Following the publication of these inflation figures, market expectations for a 25-basis-point rate cut in November surged to 92%, up from 80%. Analysts are also pricing in a likely follow-up rate cut in December. If the BOE proceeds with these reductions, the key interest rate could fall to 4.5% by the end of the year. The central bank, which had already begun cutting rates in August, held steady in September but now appears more likely to continue easing its restrictive policy.

The BOE’s decisions may also be influenced by a fall in wage growth reported earlier in the week by the ONS. Lower wage growth could further support the case for loosening monetary policy, as inflationary pressures linked to labor costs decline.

Market Reactions and Future Outlook

The release of the lower-than-expected inflation data caused a drop in the British pound, with sterling falling 0.6% against the U.S. dollar to $1.299, dipping below the $1.3 mark for the first time since September 11. The British currency also dropped 0.5% against the euro.

Additionally, yields on British government bonds, or gilts, fell across the board. The two-year gilt yield declined by 9 basis points, while the 10-year gilt yield dropped by 7 basis points.

Although inflation has eased from a peak of 11.1% in October 2022, some economists remain cautious about the longer-term outlook. Suren Thiru, economics director at the Institute of Chartered Accountants in England and Wales, noted that while the latest figures are reassuring, inflation could rebound in October due to an increase in the energy price cap. Thiru also emphasized that the BOE might wait for the UK Labour government’s budget at the end of October to assess any potential inflationary impacts before committing to further rate cuts.

Similarly, Paul Dales, Chief UK Economist at Capital Economics, warned that part of the weakness in core and services inflation was due to a significant drop in airfares. Dales predicted that the BOE may proceed with gradual 25-basis-point rate cuts at every other meeting but expects rates to eventually fall to 3.00%, below the 3.50-3.75% currently priced into markets.

Risk from the Upcoming Budget

The upcoming UK budget on October 30 presents another potential risk for the BOE’s decision-making. Sanjay Raja, Chief UK Economist at Deutsche Bank, suggested that while the inflation figures will be welcomed by the BOE, the government’s fiscal policies may still pose challenges. Raja expects the budget to be expansionary, which could add inflationary pressure despite ongoing fiscal consolidation.

As the BOE weighs its options, the central bank is expected to carefully monitor both the impact of the government’s policies and the global economic environment before determining the pace and scale of its rate-cutting cycle.

10-Year Treasury Yield Dips Slightly as Traders Weigh Fed Officials’ Comments

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The yield on the 10-year U.S. Treasury saw a slight dip early Wednesday as bond traders processed recent remarks from Federal Reserve officials regarding the future of interest rates. As of 2:15 a.m. ET, the yield on the 10-year Treasury had fallen by over 1 basis point to 4.021%, while the 2-year Treasury yield was also down, dropping 1 basis point to 3.941%. Yields and bond prices move inversely, with one basis point equaling 0.01%.

The bond market reopened Tuesday following the Columbus Day holiday, and traders have since been grappling with mixed signals from various Fed representatives about the trajectory of monetary policy.

Mixed Messages from the Federal Reserve

On Monday, Minneapolis Fed President Neel Kashkari hinted that any future interest rate cuts would likely be “modest,” stressing that decisions will continue to hinge on incoming economic data. In a similar vein, Fed Governor Christopher Waller urged caution in reducing rates too soon, indicating that the economy is still showing signs of resilience.

However, on Tuesday, San Francisco Fed President Mary Daly took a different stance, suggesting that the Fed still has room to lower interest rates further. Daly highlighted that rates are still far from their “neutral” level, where the economy can stabilize without stimulating or restricting growth. She noted that this neutral rate could be higher than in previous economic cycles, implying that the process of adjusting rates downward may take longer than expected.

“We’re a long way from where it’s likely to settle,” Daly remarked, emphasizing the challenges in determining the speed at which rates will approach their neutral level. This uncertainty has led traders to cautiously adjust their positions in the bond market.

A Pause in Fed Activity

No Federal Reserve officials are scheduled to speak on Wednesday, and there are no major economic data releases expected. This temporary pause in public remarks allows bond traders to further digest recent statements and assess the broader economic landscape, particularly as they wait for future indicators that could offer more clarity on the Fed’s path forward.