A preferred monthly inflation gauge registers its highest increase in a year, even as the annual inflation rate maintains its downward trajectory.
Mixed signals released by the Bureau of Economic Analysis underscore the uneven nature of taming inflation, affirming the cautious approach taken by policymakers at the Federal Reserve, who have refrained from prematurely declaring victory over inflation by initiating interest rate cuts. The key findings from January’s Personal Income and Outlays report are outlined below.
A 3.2% adjustment in social security, increased dividend checks, and a 0.4% uptick in wages fueled income growth. Although marking the most substantial increase in 18 months, this surge failed to translate into significant consumer spending. Much of the income gain was absorbed by a 6% rise in personal taxes, nullifying any substantial boost to real disposable income. Consumer spending slowed after a notable surge during the holiday season, with inflation-adjusted spending declining for the first time in five months. Notably, consumers favored services over goods in January.
Overall prices increased 0.3%, while core prices, which exclude food and energy, surged by 0.4%, marking the largest rise since January. Food prices rose 0.5%, while gasoline prices fell 1.4%. However, these upticks were insufficient to reverse the trend of declining inflation when measured over the preceding 12 months. The 12-month PCE price index decelerated from 2.6% to 2.4%, while growth in the 12-month core index slowed to 2.8% from 2.9%.
Policymakers favor the PCE price index when making policy decisions, and this reading is the last before their March 19th and 20th meeting. The substantial monthly index increases underscore the challenging path back to the Federal Reserve’s 2% target, justifying their cautious stance on lowering the benchmark rate and likely delaying any reduction.
Over the past year, consumers have shifted spending from goods to services. During the pandemic, government-issued supplemental checks stimulated consumer spending on goods since people were confined to their homes and reluctant to venture out, which exacerbated supply chain challenges and led to price increases. However, companies have since resolved most supply issues, prompting many goods producers, particularly those in large-ticket items like motor vehicles, to reduce prices. Additionally, higher interest rates have tempered demand for big-ticket items like vehicles and homes, resulting in a 1.2% decline in January’s goods purchases and a 0.2% drop in prices.
The rising price levels of services remain a significant concern of policymakers because they are more challenging to control. Service demand is less affected by interest rates than goods, but their prices are tied to wages, which continue to climb, albeit at a slower pace than in 2022. Labor shortages have prompted employers to raise wages, subsequently leading to price hikes to protect profit margins. Service prices rose by 0.6% in January. Policymakers will be attentive to the Bureau of Labor Statistics’ Employment Situation report for February, scheduled for release on March 8th, to gauge the labor market’s resilience amidst signs of modest softening. Following its publication, our summary and analysis will be available on HigherRockEducation.org.
