Sticker shock: what is driving US inflation higher?

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Line chart of Year-over-year change (%) showing US consumer price index soars

US consumer prices bounded higher in June at the fastest pace in roughly 13 years, surpassing even the loftiest forecasts, casting a shadow on the Federal Reserve’s claim that the inflation associated with the economic reopening will be purely a “transitory” phenomenon.

The Bureau of Labor Statistics’ consumer price index jumped 0.9 per cent last month from May, up 5.4 per cent over June 2020. Even stripping out volatile items such as food and energy, “core” CPI came in hot at an annual rate of 4.5 per cent.

Here’s what is — and is not — driving the jump:

Used cars

Surging prices for previously-owned vehicles drove the bulk of the increase last month, up 10.5 per cent on the previous month and 45 per cent from June 2020, accounting for a third of the rise in CPI.

Jay Powell, Fed chair, has repeatedly invoked used car prices as evidence for the temporary nature of the current inflation surge, especially in light of the semiconductor shortage that has caused severe disruption to vehicle production.

“Used car prices are going up because of sort of a perfect storm of very strong demand and limited supply,” he said at the press conference following the Fed’s last meeting on monetary policy. “It’s going up at just an amazing annual rate. But we do think that it makes sense that would stop, and that in fact it would reverse over time.”

Powell has also told investors to pay heed to “base effects”, which cause year-over-year increases to look outsized given the collapse in activity at the height of the pandemic last year.

Line chart of US CPI previously-owned cars and truck index (year-over-year change, %) showing Used vehicles price appreciation smashes records

Energy prices

Fuel prices have surged this year as Americans shake off pandemic restrictions and take to the roads again, with energy costs last month rising 1.5 per cent relative to May. On a year-over-year basis, they are up 4.5 per cent.

Petrol prices climbed 2.5 per cent in June from May. Demand for petrol reached a record weekly high ahead of the Fourth of July holiday, helping push national average fuel prices to about $3.10 a gallon. That is the highest in nearly seven years and 40 per cent higher than this time last year. Prices are even higher in big metro areas, with drivers paying well over $4 a gallon at the pump in California.

There may not be much relief on the horizon for consumers. Fuel prices are up on the back of strong global crude prices, which have topped $70 a barrel in recent weeks, the highest since 2018.

Travel

The loosening of Covid-19 lockdowns also fuelled another bumper month for airfares and hotel prices. Between May and June, prices for airfares jumped 2.7 per cent, while hotel charges bounded 7.9 per cent higher. Since June 2020, the sectors have seen increases of roughly 25 per cent and 17 per cent, respectively.

Car rental costs have also ballooned, with consumers facing prices in June that were 5.2 per cent higher than the previous month.

“With these increases, the price index for hotels is now well above its pre-Covid level, while the price index for airfares still has some further room to run,” said Ellen Zentner, chief US economist at Morgan Stanley. “While pandemic-sensitive price increases should eventually begin to contribute less to the overall CPI, there is still scope for significant contributions to linger.”

Rents

One area of concern for economists was a pick-up in owners’ equivalent rent, which measures what homes would rent for.

As the “largest and most sticky component of the CPI”, according to Aneta Markowska, chief economist at Jefferies, it suggests inflationary pressures are beginning to broaden out beyond the areas most sensitive to the pandemic recovery.

Prices rose by 0.3 per cent month-over-month in June, in line with the increase in May, but were elevated enough to generate attention. Compared to June 2020, prices are higher by 2.3 per cent.

“CPI rents are slow to adjust to reality as individual properties are surveyed only once every six months,” Markowska said. “Recent gains in market rents point to continued [or] significant upside in the coming months. So even, if used car prices reverse, putting downward pressure on the CPI, rents will be pushing in the opposite direction.”

Line chart of US CPI owners' equivalent rent (year-over-year change, %) showing Inflationary pressures begin to broaden out

Services

Not all sectors of the economy are contributing to the boom in prices. Medical expenses and the cost of household furnishings were among a small number of important sectors where prices decreased last month.

But it has become far more expensive to eat out, with food prices away from home 0.7 per cent higher than the previous month. Compared to the same time last year, costs are 4.2 per cent higher.

Andrew Hunter, senior US economist at Capital Economics, said the increase provided “clear evidence that the severe labour shortages and resulting upward pressure on wages in the leisure sector [are] feeding through. Both trends look to have much further to run.”

As such, economists warn it is becoming increasingly difficult to dismiss the risk that inflation could be more persistent than initially expected. 

“The most spectacular increases remain in those reopening categories, so it is fair to say the bulk of the increases are transitory,” said Stephen Stanley, chief economist at Amherst Pierpont. “But the problem is when you are running at this pace, you are still left with some pretty hefty increases . . . and some of the underlying categories are starting to show acceleration.”

Additional reporting by Justin Jacobs

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