U.S. inflation hit a new multi-decade high of 8.6 percent in May, which was ahead of what economists were expecting. U.S. inflation rose at an annualized pace of 8.3 percent in April, which was below the 8.5 percent in March. At the time, many analysts said that U.S. inflation had peaked. Notably, April was the first time in nine months that U.S. inflation had fallen.
However, inflation didn't peak in April as many anticipated and rose the next month. The worse-than-expected inflation forced the U.S. Federal Reserve’s hand into raising rates by 75 basis points at the June meeting. Could U.S. inflation still get worse or has it peaked finally now as the Fed has embarked on the most aggressive tightening since 1994?
What’s causing inflation in 2022?
Before we analyze whether inflation has peaked, it would be prudent to look at the various factors that are driving inflation. These are:
- Global supply chain crisis
- Higher raw material and input costs
- The rise in energy prices
- Spread of COVID-19 in China
- Demand-supply mismatch for many goods
- Accommodative fiscal and monetary policy
Apart from addressing the aggregate demand in the economy, the Fed’s rate hike might not help address other factors that are causing inflation.
Fed Chair Jerome Powell discussed inflation.
Fed Chair Jerome Powell was quite sanguine about the Fed's limitation in taming inflation. In the Fed's release announcing the 75 basis point rate hike, it blamed the Russian invasion of Ukraine, and lockdowns in parts of China due to COVID-19, for aggravating the supply chain crisis.
Speaking with reporters, Powell said, “I think events of the last few months have raised the degree of difficulty, created great challenges.” He added, “And there’s a much bigger chance now that it will depend on factors that we don’t control.”
Has inflation peaked in the U.S.?
As Powell also admitted, many of the factors that are causing inflation, especially high energy prices, are beyond the Fed’s control. While Fed’s rate hikes will lead to moderation in demand and also impact raw material and other input costs, it can't address supply chain issues that are beyond U.S. borders.
As things stand today, it would be preposterous to call a peak in inflation. The wild card for inflation remains crude oil whose price movement would depend to a great extent on the progression of the Russia-Ukraine war, and the Western response, including sanctions.
However, if energy prices stabilize or fall from these levels, we should see a fall in inflation. There are visible signs of a slowdown in the U.S. economy and companies would have to lower prices, especially as input costs fall. Central banks globally are looking to tighten the monetary policy, which would also slow the global economic growth, and hopefully, inflation should come down globally.
There are recession risks in the U.S.
Recession risks are also increasing and while U.S. President Joe Biden has said that a recession isn't inevitable, many economists believe that a recession could hit the U.S economy over the next 12 months.
If the U.S economy indeed enters into a recession, the resultant demand destruction might help bring down inflation. While recessions are otherwise dreaded, under the current circumstances, the Fed might not fret over the trade-off over a short recession if it helps in taming multi-year high inflation.