The Federal Reserve has a few more bridges to cross before it can finish the so-called last mile of its effort to bring down inflation. February’s consumer price index report highlighted the signposts for those bridges: elevated housing costs, persistent increases in services prices and the tight labor market’s wage pressures. All are important issues if the central bank is to achieve its 2% goal. “This is telling us the same story that we had before, which is that inflation is gradually slowing, but it’s going to take some more time for inflation to get back to the 2% objective,” said Gus Faucher, chief economist at PNC Financial Services. The CPI, which measures the prices of dozens of goods and services across the sprawling U.S. economy, showed a 3.2% annual increase from a year ago, slightly higher than the Dow Jones estimate and the January reading. Excluding food and energy, the inflation rate was at 3.8%, also higher than expected. Though both readings are well off the peaks in the summer of 2022 — the highest levels in more than 40 years — they are well ahead of the Fed’s goals. As such, inflation is complicating the central bank’s stated intention of reducing interest rates at some point this year. The three obstacles standing in the Fed’s way could be formidable but are showing signs of progress. Policymakers expect idiosyncratic factors in shelter readings to reverse later this year, easing pressures on shelter costs that eat up one-third of the CPI weighting. Core services costs excluding housing services — “supercore” inflation, as it has become known — remain elevated but at least the pace of increase, at 0.5%, has eased. And wage pressures, though up for debate on how much they’ve influenced inflation, also appear to be pulling back. While average hourly earnings increased again in February, inflation-adjusted pay actually decreased 0.4% on the month and was up just 1.1% on a year-over-year basis, according to the Bureau of Labor Statistics. The bad news: tight monetary policy in the form of high interest rates and reduction of the Fed balance sheet may not do much to help. “The ‘last mile’ problem for the central bank is the inflation in service prices, which is partly attributed to the tight labor market in sectors such as healthcare, leisure, hospitality, and construction. This has led to increasing costs for services ranging from dining out to personal care and home repair,” wrote Sung Won Sohn, finance professor at Loyola Marymount University and chief economist at SS Economics. “This type of inflation, often termed ‘cost-push inflation,’ may not react straightforwardly to changes in interest rates.” The current inflation wave marks a stark contrast from the post-financial crisis economy where inflation stayed mostly subdued from the end of the crisis in 2009 until the Covid pandemic in March 2020. A decade ago, headline CPI inflation was at 1.1% and core was at 1.6%, characteristic of the tight zone in which inflation ran for the time period. At that time, annual shelter inflation was 2.6% compared with 5.7% now, services less energy was 2.2% compared with 5.2%, and average hourly earnings were 2.3% compared with 4.3%. “Wage growth was significantly slower, the labor market wasn’t as tight,” PNC’s Faucher said. “It wasn’t that long ago, but it was a different economy than it is now, with some of those [current] post-pandemic effects of the tight housing market and the tight labor market.” Still, Faucher expects the Fed to get inflation down, whether it’s by taking the same data-dependent go-slow approach that officials are advocating now, or if it has to tighten policy even further, which obviously would be a less desirable approach. JPMorgan Chase CEO Jamie Dimon on Monday advised the Fed to move slowly on cuts and said a recession isn’t out of the question this year. “The Fed’s going to get there. That’s not the question,” Faucher said. “The question is, do we get there with slowing growth and a soft landing, or do we get there with a recession? The Fed is fully committed to that 2% objective. If inflation doesn’t slow over the next six months or so and the Fed is forced to keep the fed funds rate where it is or even increase it, that raises the risks of recession.”
