The United States consumer price inflation surged to the highest level last seen since February 1982, worsening the outlook for inflation as rates surge above economists estimates.
According to data issued by the US Labor Department, the Consumer Price Index (CPI), which measures the average price of goods and services purchased by households in the US, increased by 7.5 per cent in January 2022 compared to January 2021.
Core inflation which excludes volatile items like food and energy prices from the Consumer Price Index also rose to the highest level since 1982, while month-on-month inflation appreciated to 0.6%, surpassing analysts’ estimates of 0.4%.
The drivers behind price pressures
Over the past months, inflation rates in the USA have risen to levels last seen in decades with the January inflation rates coming in at 7.5% after surpassing the previous record set in December which touched 7%.
The sporadic spike in prices of goods and services is due to a supply shortage that couldn’t keep up with strong customer demand. The pandemic’s disruption to the global supply chain is still causing output shortages thus driving up the price of goods ranging from vehicles to energy and food items.
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On the demand side, policymakers’ accommodative monetary and fiscal measures, which included extraordinary stimulus checks from Congress, business payroll support, and Federal Reserve interest rates at historic lows, led to the expansion in money supply and the strengthening of consumer demand.
Fuel, Food, Clothing and Rent contributed the most to price increase in the United States in January 2021. On a percentage basis, fuel prices rose by 9.5% month-on-month in the USA, and this is not surprising as the prices of global crude oil prices have risen over 27% in 2022.
In addition, vehicle prices grew by 1.5% month over month, while home prices increased by 4.4% on an annualised basis. The disruption in the food supply chain, combined with a shortage of migrant labour as a result of covid-19 social distancing measures, resulted in a 7% yearly increase in food prices.
The persistent rise in inflation rates represents a decline in Americans purchasing power as more dollars are being used to purchase fewer goods.
The economy paradox
Although the US economy grew to one of its highest levels last seen in 37 years as Gross Domestic Product (GDP) rose to 6.9% on an annualised basis. One of the main drivers of the strong GDP performance was the rising consumer spending which shows that more Americans spent on goods and services in the past quarters, a sign of economic growth as this represents a decrease in unemployment rates and an increase in production levels.
Although the US economy grew to one of its best levels in 37 years, with GDP rising to 6.9% on an annualized rate. Rising consumer spending was one of the key drivers of the high GDP performance, signalling economic expansion as more Americans spent on goods and services.
As more money chases fewer items, the growing trend in price erodes customers’ purchasing power. As a result, the Federal Reserve (Fed) is expected to raise interest rates to combat inflation, but this could harm the economy in the short term because individuals and businesses will be able to access credit at relatively high rates.
The next step on policy front
The rising inflation level threatens the objectives of the US Federal Reserve (central bank) to maintain price stability and economic growth, as January inflation rates surged to 7.5% – a level unseen in decades.
The Federal Reserve (the US central bank) previously labelled the recent increase in inflation as “transitory,” implying that it will only have a short-term impact on the economy. However, Federal Reserve Chair Jerome Powell previously stated that it was time for the central bank to withdraw its emergency pandemic measures in a public speech. As a result, the Federal Reserve is preparing to hike interest rates to keep inflation under control and has indicated that it might do so as soon as March 2022.
The central bank officials think that the US Federal Reserve has met its mandate on employment and inflation, and hence could tighten its monetary policy. As a result, we anticipate that a rate hike in the United States will dictate the course of businesses, households, and financial markets.
Why You Should Care
The stock market today tumbled as the S&P 500 slid over 2% in response to the higher inflationary figure of 7.5%. The stock market’s loss is due to expectations of a rate hike by the US Federal Reserve, as a high-interest rate means a high borrowing cost for firms, which might affect corporate profitability. As a result of the drop in corporate profits, future dividends given to investors will be reduced, prompting a change in investment decisions away from risky assets and toward lower-risk stocks that benefit from higher interest rates, such as financial companies.
As investors, traders and businesses brace for higher interest rates from the Federal reserve, we maintain that investors apply a more cautious approach to investing this year.
