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Economic Report: Peak inflation? The worst may be over, but Americans to keep paying a high price

The 8.5% surge in the cost of living in the past year could represent the peak of the worst U.S. inflation in 40 years — but Americans can’t expect much relief from rising prices this year or even next.

The rate of inflation has jumped more than six-fold in the past 14 months from as low as 1.4% at the beginning of 2021. The cost of fuel, food, housing, cars and all sorts of stuff have soared.

Gas prices have jumped 48% from one year ago, for example, and the cost of groceries have climbed 10% to mark the biggest increase in four decades.

“Every time you fill up at the gas station it hurts,” said Robert Frick, corporate economist at Navy Federal Credit Union. “People are going to be paying even more for meat, to which they are very sensitive.”

The sharp and relatively sudden surge caught the Federal Reserve — the nation’s guardian against high inflation — entirely by surprise. Alarmed by the spike in prices, a late-reacting Fed is now speeding up plans to lift low U.S. interest rates quickly to try to put the genie back in the bottle.

“ “Every time you fill up at the gas station it hurts.” ”

— Robert Frick, Navy Federal Credit Union

Economists predict the increase in inflation will decelerate by year end to 4% to 5%, but they say the central bank waited too long to act. It could take several years, they say, before the Fed’s bitter new medicine pulls inflation closer to its 2% to 2.5% target.

“Clearly they waited too long to get going,” said chief economist Stephen Stanley of Amherst Pierpont Securities, one of the first Wall Street pros to sound the alarm on inflation last year. “It’s going to take them awhile to catch up.”

How the U.S. got here

The roots of today’s inflation run deep.

The Biden and Trump administrations pumped trillions of dollars into the economy during the pandemic to soften the blow. At the same time, the Fed slashed interest rates to record lows and kept them there until just last month.

In short, the economy was flooded with an unprecedented amount of money.

Then as the economy reopened last spring and Americans began to spend freely again, disruptions in global trade tied to the pandemic prevented businesses from being able to obtain enough labor and supplies to meet the demand.

The combination of huge fiscal and monetary stimulus and big shortages has spawned the worst bout of price increases since the late 1970s and early 1980s, when U.S. inflation peaked at almost 15%.

High inflation is also starting to feed into the biggest increase in worker pay in decades, spawning worries about a dreaded wage-price spiral that would make high inflation more long lasting and harder to conquer.

If Americans come to expect high inflation, they’ll ask for more pay. Businesses in turn will charge even higher prices. And on and on the merry-go-round would go — until the economy crashed.

Contrite Fed officials are trying to make amends by more aggressive increases in interest rates, but most still insist that inflation will taper off relatively quickly.

The Fed predicts the rate of inflation will slow to 4.3% by year end using its preferred PCE price barometer. And then drop to 2.3% by the end of 2024.

“This is not the kind of inflation from the 1960s and 70s,” Chicago Fed President Charles Evans said on Monday.

Evans contended the current burst of price pressures is more temporary in nature. He argued inflation will revert back to the low levels that prevailed before the pandemic in a year or two.

Fed officials are likely to take solace from a small 0.3% increase in March in a closely follow inflation barometer known as core consumer prices. It matched the smallest gain in six months.

Yet just as it took time to reduce inflation four decades ago, most economists predict a longer road ahead than the Fed expects.

“The Fed is still largely expecting inflation to self correct and mostly go down on its own,” said chief economist Aneta Markowska of Jefferies, another Wall Street analyst who raised questions about rising prices early on last year.

“I think they are too optimistic on inflation coming down.”

Is the worst over?

So why does the Fed and so many economists — even skeptics like Stanley and Markowska — expect the rate of inflation to slow this year? They think the inflation wave either crested in March or will do so in April.

Some like UBS even see the runup in prices mostly reversing by year end.

Fed interest rate hikes this year might restrain inflation a little by making big-ticket items like new houses and autos more expensive, for one thing.

More importantly, the supply-chain bottlenecks that have contributed so much to high inflation are expected to continue to ease.

If businesses can obtain more supplies, the thinking goes, they won’t have to pay as much for materials or charge customers as much for their goods and services.

Finally there’s a statistical mirage of sorts known in economist lingo as “base effects.” As high monthly inflation readings from last year drop out of the 12-month average, it makes headline inflation seem lower.

Take last June, when the consumer price index leaped 0.9%. If several months from now, the CPI rises, say, 0.5% in June, it would make the yearly increase in inflation look smaller.

It wouldn’t necessarily mean that price pressures are easing, though.

A half-point increase in monthly inflation is still historically high, for one thing.

What’s more, the annualized rate of inflation in the first three months of 2022 is still extremely troublesome at 11.3%. That’s how much inflation would rise this year if it increased at the same pace in the final nine months as it did in the first three.

Then there’s the war in Ukraine and Covid lockdowns in China, both of which could exacerbate inflation in the short run.

Russia is a major producer of oil and grains and Ukraine is also a large grain grower. The war has added to the upward pressure on fuel and food prices and the effects could persist well after the conflict is over.

In China, factory closings and the lockdowns affecting millions of people could stanch the flow of goods to the U.S. and put renewed stress on strained supply lines.

The Fed’s big challenge

The real fight to significantly lower inflation is in 2023, economists say. And one of the most “dovish” Feds in history, as Stanley calls it, will only achieve some success if it is aggressive.

That could mean raising a key short-term U.S. interest rate above the central bank’s current goal of 2.8% by the end of 2023 — and possibly slowing the economy to the point of recession.

“Inflation is likely to decelerate, but left on its own, not very rapidly,” said Joel Naroff of Naroff Economic Advisors.

He said there’s still too much demand that businesses can’t meet, a problem that would only be rectified by the Fed icing down a hot economy.

Yet even an aggressive central bank may be limited in what it can achieve quickly. Markowska pointed to a New York Fed study showing consumers think inflation will rise 6.6% in the next year — the highest reading on record.

What do Americans plan to do in response? Keep spending, the survey shows.

Many households have the means to do so.

Wages, for example, have jumped 5.6% in past year to mark the biggest increase in decades and help Americans cope with a higher cost of living. And thanks to unprecedented government stimulus, Americans have an extra $2 trillion-plus of savings in the bank than they did before the pandemic.

“Nobody likes to pay higher prices. The question is, what are consumers going to do about it,” Markowska said. “They are not pushing back at all. They are paying higher prices and moving on.”

If that keeps up, though, Americans will have to use up their savings and eventually find other ways to afford the higher cost of fuel, steak or a beach vacation.

“That’s when you walk in and say to your boss, ‘I need a raise,’ ” Stanley said.

While rising pay would be a good thing for workers, it would give companies even more reason to raise prices and prolong the bout of high inflation.

“I think inflation is going to be around 3% to 4% around the end of the year, but stay stubbornly high relative to the preceding decade,” said Steve Blitz, chief economist of TS Lombard.

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