The biggest surge in U.S. prices in 40 years is over, but the fight against inflation is not.
First the good news.
Consumer inflation only rose 0.2% in July, the third soft reading in a row. Consumer prices have climbed 3.2% in the past year, just one-third of last year’s 9.1% peak.
Another measure of inflation preferred by the Federal Reserve was also quite mild last month.
The rate of inflation, however, is still running well above the Fed’s 2% target. Before the pandemic, inflation increased less than 2% a year.
The annual increase in the so-called core CPI, seen by the Fed as a better predictor of inflation trends, only fell a tick to 4.7% in July from 4.8%. It still has a long way to fall.
What’s going to be crucial for the Fed in getting core inflation down is a retreat in labor costs — not only wages and salaries, but also benefits.
So far the evidence is mixed.
Labor costs are also rising more slowly, but are still running well above trend as workers understandably seek more compensation to offset the higher cost of living.
In the past several months, for instance, employees at UPS
UPS,
and other large companies have won sizable increases in wages.
The increase in hourly pay, meanwhile, has gotten stuck around 4.4% since the early spring, far too high for the Fed’s comfort.
Labor is the biggest expense for most businesses, especially in the huge service side of the economy. That’s where inflation is still being felt the strongest.
“If inflation labor-intensive sectors fails to slow further, the Fed will have a very hard time driving out the last bit of above-target inflation,” said U.S. economist Thomas Simons at Jefferies.
“The recent resilience in average hourly earnings in the employment data, combined with the success of large labor unions in negotiating substantial increases in wages and benefits for their members suggests that the risk of a rebound here is significant,” he added.
To hit its 2% inflation target, economists say, the annual increase in labor costs will have to slow to 3.5% or preferably less.
If they don’t, the core rate of inflation could get stuck above 3% for a while.
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