U.S. May CPI: Inflation continues to broaden out on higher gas and housing costs

REAL ECONOMY BLOG | June 10, 2022

Authored by RSM US LLP

Inflation continued to broaden out across the American economy in May, rising by 8.6% annually and underscoring the urgency among central bankers to restore price stability through an increase in the federal funds rate and a drawdown in its $8.9 trillion balance sheet.

Rising prices now include the dominant service sector, where inflation is up by 5.7% on a year-ago basis.

Six months into the Federal Reserve’s rate-hike campaign, one can observe a tightening of financial conditions, a cooling in the housing market and a slowing in auto sales while inflation continues to push up costs higher everywhere else.

These higher costs now include the dominant service sector, where inflation is up by 5.7% on a year-ago basis, alongside the 8.6% top-line number, which represents a new cyclical peak.

Any notion of a Federal Reserve slowing its rate hikes or pausing in its efforts to push interest rates higher along the maturity spectrum should be tempered. If anything, the idea of a 50-basis-point rate hike in June and July should now be considered alongside another 50-basis point increase in the policy rate in September, which is now clearly in play.

Attempts by the Federal Reserve to engineer a controlled burn of the economy back toward into the inner atmosphere without doing too much damage to the real economy just got that much more difficult.

The policy rate is going to move into restrictive terrain near 3% or higher by the end of the year, which will result in the probability of a recession rising into next year.

Given the direction of global oil prices and gasoline costs following the European Union’s decoupling from Russian energy exports and the coming increase in food costs, the probability of the Fed achieving a soft landing is diminishing month by month as lower- and middle-income cohorts absorb those price increases.

Monthly CPI

The data

The primary driver of the top-line 1% monthly increase in inflation are rising energy, gasoline and housing costs that will cause the economy to slow back toward its long-term growth rate of 1.8% this year and next.

Energy prices increased by 3.9% in May and gasoline costs jumped by 4.1%; those two costs rose by 34.6% and 48.7%, respectively, on a year-ago basis.

The service sector, which comprises the overwhelming majority of the domestic economy, increased by 0.8% on the month and was up by 5.7% from a year ago. Service costs excluding energy increased by 0.6% in May and were up by 5.2% from a year ago.

Housing costs, which in our estimation will be the major policy challenge for the fiscal authority over the medium to long term, saw an increase of 0.8% on the month and were up by 6.9% from a year ago. Shelter costs advanced by 0.6% monthly and 5.5% annually. The policy-sensitive owner’s equivalent rent series advanced by 0.6% in May and was up by 5.1% on a year-over-year basis.

Fiscal policymakers will have to create incentives to build more homes.

CPI by category

Food and beverages costs increased by 1.1% on the month and were up by 9.7% from a year ago. Food costs increased by 1.2% on the month and by 10.1% over the past 12 months. Apparel costs increased by 0.7% on the month and by 5% annually.

Airfares increased by 12.6% in May following an upwardly revised 18.6% increase in April and were up 37.8% from a year ago. Medical care costs increased by 0.4% in May and were up by 4.0% over the past year.

The takeaway

Inflation posted a new cyclical peak of 8.6%, driven by higher food, fuel and housing costs. Service sector costs are now part of an economic narrative of a broadening out of inflation that requires sustained policy action out of the Federal Reserve that will push its federal funds rate to 3%. Such an increase will put the policy rate in restrictive terrain and result in a slowing economy, all of which will only increase the probability of a recession next year.

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This article was written by Joseph Brusuelas and originally appeared on 2022-06-10.
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