What Does the Latest CPI Data Tell Us?
On July 13, 2021, the US Bureau of Labor Statistics (BLS) released the CPI data for June. The Consumer Price Index (CPI) is one of the important gauges used to measure inflation, although it is not the only metric that the central banks rely on for monetary policy decisions. The index increased 0.9% from May to June, and 5.4% year-over-year, which was way above expectations. The yearly gain in. the index was expected to be less than 5%, so the actual data was quite surprising for Wall Street.
According to BLS, the majority of the gains in the index stemmed from used and vehicles, fuel, airline fares, and apparel. It is not surprising that the chaos in the car industry regarding the chip shortage, supply bottleneck, and higher than expected demand is impacting prices. Airline fares were at record lows in 2020 due to the pandemic, and the economic recovery is pushing demand back to pre-2020 levels.
Many people are concerned about the rising probability of higher ‘persistent’ inflation, which can force higher interest rates, leading to lower asset prices and higher borrowing costs. The Federal Reserve counters that inflation is ‘temporary,’ and that once everything gets back to normal and supply chains function normally, inflation is likely to cool down. The ‘base effect’ is also responsible for an unusual increase in inflation. If you compare the statistics from 2020, everything will seem higher in 2021, because 2020 was a year where economic activity was impacted severely, leading to short-term extreme price fluctuations. For example, gas prices were extremely low in 2020 due to record low demands, and 2021 gas prices are rising because economic activity is slowly resuming.
I decided to compare the June 2021 statistics to June 2019. This method allows to look at the annualized increase in CPI index, which might remove the impact ‘base effect’ can have on the yearly inflation. The aggregate CPI index increased 6.07% from June 2019 to June 2021, which translates to a 2.991% annualized increased. You can see from the following table below the annualized increase in CPI index when compared to 2019.
As you can see from the table above, inflation has started to pick up gradually when compared to 2019, and since March it has been above the 2% target set by the central banks. Now, as mentioned supply chains constraints are still present, and the higher demand is putting a pressure on prices in certain sector, such as the auto industry. The used car and truck index is responsible for one-third of the increase in the aggregate index, so these one-time issues can put a temporary pressure on prices. Overall, majority of the categories in the CPI did not see much fluctuations, except for a few which I mentioned above.
It will be interesting to see if more than 2% annualized inflation will continue throughout the year or will it cool down after summer break is over. The delta variant also made its way to the US, which might impact the economic recovery, but according to professionals, the vaccines are capable of working against it. According to reports from China, there has been some slowdown in economic activity, leading the Chinese government to inject more than $150 billion into the economy. If inflation persists throughout the year, then the Federal Reserve might be forced to hike interest rates sooner. It will be interesting to see how the world reacts to a higher interest rate, since low rates have been a norm for a very long time.