The Fed faces a long battle to bring inflation down to its 2% target

Economists and policymakers are preparing for a long, difficult road back to the US Federal Reserve’s 2 percent inflation target, even as early signs of relief emerge in the wake of the worst shock in decades.

Recent economic data suggests that price pressures are finally starting to abate, with last week’s consumer price index showing that the persistent rise in costs of some goods and services is leveling off or about to do so.

But the optimism clashed with lingering concern about how quickly “core” inflation – which excludes volatile food and energy prices – will decline from here. Over the past two years, hopes have been raised by only encouraging data for inflation to continue to rise.

“Not only will it be a bumpy road, but what we worry about are the sticking points because [those] Diane Sunk, chief economist at KPMG, said:

Lawrence Ball of Johns Hopkins University added, “I’m very aware, as people are, that you can falsify a head with two months of data.”

Keeping inflation-fighters on guard is the fact that the sources of higher prices at this point stem from a wide range of services, from child care to hair cuts, which tend to require more effort on the part of the Fed to root out.

As the economy recovered from the shock of Covid-19, supply chain disruptions combined with lockdowns — which limited how people spent savings due to generous federal aid — produced a historic boom in the prices of everyday items like washing machines and furniture. At one point, the price of used cars was increasing at an annual pace of nearly 40 percent as the shortage intensified, accounting for more than a fifth of overall inflation.

But as initial Covid fears recede and restaurants, cinemas and other venues reopen, service-related inflation is starting to climb. Housing costs have also rebounded. Americans, buoyed by an overheating job market and better wages, were willing to put up with the higher prices that companies began charging to cover their inflated expenses, accelerating a rise in inflation that has since prompted stern action from the US central bank.

In the past 15 months, the Fed has raised its benchmark interest rate by more than 5 percentage points, the fastest increase in decades as it sought to curb demand. Officials are now contemplating whether they have done enough or if they need more pressure on the economy to ensure that inflation – as measured by the core PCE price index – returns to the Fed’s 2 percent target. As of March, it was running at an annual rate of 4.6 percent.

After last week’s data, Amir Sharif, head of inflation forecasting group Insights, said “most parts are ready” for a gradual easing of core inflation from here. But he cautioned that the Fed’s target will remain elusive for some time.

“It’s really hard to see core inflation drop to anything close to 2 percent by the end of this year,” he said. “We’d be lucky to be about twice that.”

Among the positive developments in the latest CPI report was growing evidence that housing inflation is starting to ease, reflecting the sharp declines in rents and home prices last year that experts have been waiting to see in the data. Also, a closely watched core measure of inflation – the so-called “essential services excluding housing” – slowed to its slowest monthly pace since July 2022.

Sharif warned that the metric can be highly volatile and disproportionately reflect travel-related expenses. But Jay Powell, chairman of the Federal Reserve, said last year that essential services once housing is stripped “may be the most important category for understanding the future development of core inflation” since it captures the dynamics around wages.

Previous bouts of high inflation provide some additional relief. Alan Detmeister, a former Fed researcher now at UBS, studied decades-long spikes in inflation and concluded that “the single best measure of inflation is probably 1947” rather than the 1970s and 1980s, which were notorious for entrenched inflation.

In the post-World War II period, inflation—propelled in part, as today, by pent-up savings, a sharp rise in government spending, and a sudden shift in consumer demand toward goods—gradually declined over time without a sharp rise in interest rates. Detmeister said this suggests the Fed doesn’t need more rate hikes, even though it may be at least a year before the Fed’s target is met.

Most economists polled by Bloomberg predicted it could take until 2025. That is roughly in line with the timeline most Fed officials had projected, according to estimates published in March. They also maintain that there will be no interest rate cuts until 2024, reflecting their view that the drop in inflation they need to support could not have happened before then.

“There is enormous uncertainty and on the inflation front, there is a real lack of confidence because you feel that the models that we thought we knew and worked well for so long in a period of very low inflationary volatility just didn’t work with all of that,” said Bill English, former head of monetary affairs at Bank of America. Federal Reserve.

“What the Fed has emphasized is that they really want to see inflation go lower before they conclude they’re in good shape,” added English, who is now at Yale University.

“Low inflation expectations aren’t going to cut it.”