A moderation of inflation?

Quick takes:

• Inflation shows signs of peaking
• Consumer inflation slowing
• Producer inflation remains elevated
• Consumer and business outlook sours
• CRE remains a solid inflation hedge

Fears of runaway inflation heated up during the first half of this year. As vaccination accelerated, consumers began rapidly returning to more conventional economic activities, boosted by fiscal stimulus and low interest rates, which in turn caused demand to increase rather quickly. But supply typically takes longer to catch up for a variety of reasons: businesses close during recessions and jobs disappear permanently, workers go through retraining and sit idle for a period, new businesses take time to hit their stride and increase production. The current recovery poses additional complications. With the pandemic still ongoing, some workers have refused to return to activities that potentially put their health at risk. Vaccination is occurring fastest in high-income countries, leaving pandemic-related disruptions to production in place longer in medium- and low-income countries. And production taken offline in anticipation of a prolonged pandemic-induced slump that did not materialize takes time to bring back online. This means we face ongoing shortages of intermediate and final goods imported from other parts of the world. With aggregate demand recovering faster than aggregate supply, the price level in the economy accelerated. 

Cooling off during a hot summer?

Yet the inflation associated with this demand/supply imbalance is already showing signs of peaking, much as we anticipated. While we cannot yet determine whether inflation has peaked, data from the consumer price index (CPI) for July provides some evidence. On a month-over-month basis, headline inflation grew by 0.47%, the lowest reading since February.  On a year-over-year basis, the headline CPI grew by 5.3%, on par with the change from June. The core CPI shows something similar. The month-over-month change registered its lowest level since March and the year-over-year change declined from June to July, falling from 4.5% to 4.2%. While this does not yet present enough evidence to declare that inflation has peaked, clearly momentum is slowing. What’s behind this slowing? The same categories that pushed up inflation earlier are now easing off. Used vehicle inflation is backing off as consumers’ needs become satisfied and rental companies rebuild their fleet after selling off inventory last year. Additionally, services associated with the resurgence in demand such as bars and restaurants, hotels, air travel, rental car prices, etc. are also seeing prices changes slow or outright decline. Even import price inflation decelerated in July. 

Inflation peaking?
 

Don’t expect a dramatic deceleration

Even as consumer inflation decelerates, it likely will not do so quickly. Supply bottlenecks coupled with a pronounced labor shortage should persist for a while, putting pressure on the prices that producers must pay for production of goods and services. The July headline producer price index (PPI) increased by 1% month-over-month which pushed the year-over-year rate to 7.8%, a record high. Similar segments to CPI growth drove this change in the PPI such as autos, air travel and hotels. Although supply disruptions should abate over time, the structural aspects of the labor shortage should prove durable – one of the key reasons why we continue to believe that inflation should ultimately settle at a level above which prevailed during the last business cycle, even as it climbs down from recent high levels. 

Outlook sours somewhat

The outlook for consumers and businesses recently turned a bit more sour in the face of the delta variant and the concern it is causing. The consumer sentiment index fell 11 points in early August to its lowest reading since 2011. Consumers feelings turned notably downward after they recalibrated their expectations for the timing of the end of the pandemic. Businesses also suffered dampening spirits, with the July NFIB Small Business Survey declining and remaining well below pre-pandemic levels. Business owners are also losing some faith in the outlook amidst continued hiring difficulties supply-chain disruptions.

What we are watching this week

Headline retail sales likely changed little in July with consumers shifting spending from goods to services. Core sales should hold up a bit better due to the absence of autos in the core series. Housing starts for July likely declined slightly due to supply-side issues. Permits for July likely increased slightly, but the outlook also remains challenged by ongoing disruptions to building. 

Thought of the week

More than 90 new airlines are launching in 2021. 

Note: We will not produce Economic Insights next week. It will return in two weeks.