There was a moment, late last year, when everything seemed to be going according to the Federal Reserve’s plan: inflation was slowing, consumers were pulling back and the overheated economy was gently cooling down.
But a spate of fresh data, including worrying figures released Friday, make it clear that the road ahead is likely to be bumpier and more treacherous than expected.
Inflation remains stubbornly elevated and unexpectedly picked up in January, a fresh reading of the Fed’s preferred index showed, underscoring the daunting challenge facing central bankers as they try to wrestle price increases back to a normal pace.
After six months of more or less consistently cooling down, the Personal Consumption Expenditures price measure climbed 5.4 percent in January from a year earlier, an unexpected pickup from 5.3 percent the prior month and substantially more than the 5 percent economists had expected.
Even after stripping out food and fuel prices, both of which jump around a lot, the price index climbed by 4.7 percent in the year through last month — also a pickup, and more than expected in a Bloomberg survey of economists.
Those inflation readings are well above the Fed’s goal of 2 percent annual price increases. And the report’s details offered other reasons to worry. The previously-reported slowdown in December inflation figures, which had given economists hope, looked less pronounced after revisions. While price increases had been consistently slowing on a monthly basis, they are now showing signs of speeding back up.
The inflation figures are just the latest evidence that neither price increases nor the broader economy are cooling as much as expected as 2023 begins. Hiring has remained abnormally robust and figures Friday showed that people continue to spend money rapidly on goods and services. Given that, Fed officials may come to believe that they need to do more to cool the economy — in particular, raise interest rates higher than the 5 to 5.25 percent range they had previously expected.
What is inflation? Inflation is a loss of purchasing power over time, meaning your dollar will not go as far tomorrow as it did today. It is typically expressed as the annual change in prices for everyday goods and services such as food, furniture, apparel, transportation and toys.
What causes inflation? It can be the result of rising consumer demand. But inflation can also rise and fall based on developments that have little to do with economic conditions, such as limited oil production and supply chain problems.
Is inflation bad? It depends on the circumstances. Fast price increases spell trouble, but moderate price gains can lead to higher wages and job growth.
How does inflation affect the poor? Inflation can be especially hard to shoulder for poor households because they spend a bigger chunk of their budgets on necessities like food, housing and gas.
Can inflation affect the stock market? Rapid inflation typically spells trouble for stocks. Financial assets in general have historically fared badly during inflation booms, while tangible assets like houses have held their value better.
“In a nutshell, it means the job is not done — in fact, it is far from done, because inflation is much too high,” said Gennadiy Goldberg, a rates analyst at TD Securities. “The economy is still strong, and consumers are still spending money.”
Stocks slipped following the fresh data on Friday, setting up to end the week lower for the third time in a row, the longest stretch of losses so far this year.
Financial markets have come under sustained pressure in recent weeks as investors have recalibrated their expectations for how long inflation could remain high, and how high interest rates could go as a result.
Fed policymakers have raised rates at the fastest pace since the 1980s over the past year, lifting them from near zero at this time in 2022 to more than 4.5 percent as of this month. The goal was to slow consumer demand and force companies to charge less, ultimately wrestling inflation lower.
But Friday’s data suggested that in spite of the aggressive action, the American economy — and particularly the consumer, which drives the largest part of economic growth — remains extremely resilient.
Personal spending, which spans both goods and services, climbed by 1.8 percent in January. That compared to a slight 0.1 percent decline in December, and was more than the 1.4 percent increase that economists had anticipated. Even after adjusting for quick inflation, consumer spending rose at a hearty pace last month.
Whether consumers keep spending in the months ahead is a key question as the Fed ponders its next policy steps. If demand remains robust, it could make it difficult for the economy to slow enough that businesses charge less and inflation eases fully back to normal.
Understand Inflation and How It Affects You
Officials signaled in December that they might need to ultimately lift rates to just above 5 percent, but those estimates have crept slightly higher in recent weeks as policymakers reacted to surprisingly strong data on jobs and consumption.
Mr. Goldberg said that Friday’s report was sure to spur speculation in markets that the Fed might speed up its rate increases, moving by a half-point rather than a quarter-point in March. Indeed, investors increased their bets for a larger half-point increase in March in the wake of the report, though expectations still tilted toward a quarter-point increase.
So far, officials have shown little interest in returning to larger rate increases, instead focusing on how high rates will climb and how long they will stay elevated.
Higher interest rates weigh on the economy by making it expensive for households to borrow to buy a car or purchase a house, and by making it pricier for businesses to finance expansions. As those transactions stall, the aftershocks trickle through the economy, slowing not just the housing and automobile markets, but also the labor market and retail and services spending as a whole.
But the full effect of policy takes time to play out, which makes it difficult for central bankers to assess in real time how much policy tightening is exactly the right amount to slow the economy and bring inflation to heel.
Fed officials will be parsing an array of data — on jobs, spending and inflation — before their next meeting on March 21-22.
They may also take a signal from recent earnings calls, which have suggested that the economy is beginning to lose some of its hotness, though it is still not fully back to normal. Corporate profit margins had expanded drastically, but could begin to stall out as firms find it increasingly difficult to charge ever-higher prices.
In 2022, “we observed a resilient customer who is less price sensitive than we would have expected in the face of persistent inflation,” Ted Decker, Home Depot’s chief executive, said on a call with analysts this week. But “we noted some deceleration in certain products and categories, which was more pronounced in the fourth quarter.”
— Joe Rennison contributed reporting.
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