While most people are cheering for the apparent end of inflation, others worry that the Fed could still hike interest rates. But why would they do it?
What was first just a suspicion is now a certainty: inflation, the economic phenomenon that trapped us for almost two years, is decreasing. Indeed, the drop seems so effective that some analysts are hoping there won’t be a recession after all. Unfortunately, we are not out of the woods yet.
On Thursday, consumer data from the United States showed the biggest drop in inflation yet, the sixth consecutive since June’s peak. Consumer prices fell to 6.5% year on year from 7.1% in November. At its peak, American inflation reached 9.1%.
Inflation was originally caused by a plethora of global and local events. The war in Ukraine and the end of Covid trumped global efforts to get out of the pandemic slump. For this reason, Europe experienced worse and higher inflation, though luckily it is slowing down there too.
The American Federal Reserve has increased interest rates for almost a year now, from almost zero to 4.25-4.50%. The goal was to slow down inflation and bring it back to the “healthy” level of 2%.
In doing so, however, many were (and still are) worried of a possible recession coming. By bringing interest rates up, the overall economy has slowed down. The stock market experienced its worst year in more than a decade, almost mirroring pre-2008 levels.
But now that inflation is going back again, the Federal Reserve will bring back interest rates too and the economy will heal, right?
The devil in the detail
Before any premature exultation, some experts are pointing out that while overall inflation is decreasing, it is not the same for every consumer price category.
Core inflation, which does not include food and energy, actually rose by 0.3%. So far, the Federal Reserve has monitored core inflation closely, always taking it into account in their decision to rise or lower interest rates.
Perhaps even more importantly, housing prices keep steadily going up. They rose by 0.8% in December, going to 8.3% annually.
“This lower-than-expected headline CPI inflation print will not make the Fed change its view on the need to keep increasing interest rates in February and March of this year,” said Raymond James’ chief economist.
Furthermore, there are also not many signs of the economy slowing down, which is typical in a high interest-rate situation. Unemployment is at its lowest in 50 years, which makes people hope there won’t be a recession, but could also push the Fed to keep increasing interest rates.
In short, inflation might still hold unpleasant surprises in 2023.
