US CPI inflation might have peaked this month, assuming there is no further escalation of the conflict in Ukraine and oil prices evolve in line with the future curve going forward. However, there are still considerable external and domestic price pressures in the pipeline – it will take some time for higher input and labour costs to pass through into consumer prices – meaning that inflation will likely remain sticky at elevated levels for the balance of the year at least.
We now expect it to average 7% this year. Further down the line, stabilisation in energy prices, base effects, an easing of global supply constraints and, crucially, a slowdown in domestic demand should all contribute to drive inflation down quickly. That said, inflation might eventually stabilise above the Fed’s 2% target, to the extent the pandemic and the war in Ukraine catalysed structural changes in the labour market domestically and in supply chains globally, while a poorly managed green transition would also prove inflationary.
Today’s inflation report on balance validates expectations that the Fed will hike by 50bps in May, as already suggested by recent FOMC communication. By the Fed’s own admission, the central bank is behind the curve in its fight against inflation and is eager to catch up with larger rate hikes and the start of quantitative tightening in coming meetings – an uncertain endeavour given that monetary policy affects the real economy with lags of between 12 and 18 months, and it is not fully clear how quantitative easing works. While the Fed still believes they will be able to engineer a soft landing, these rarely occur, and the convergence of cost-push inflation squeezing real incomes, monetary and fiscal tightening could result in a harder-than-desired hit to demand down the line.