Inflation is still high. What motivates him has changed.

America has now been experiencing abnormally high inflation for two years now – and although the country appears to be past the worst phase of the biggest price hike in half a century, the road back to normal is long and uncertain.

Soaring prices in the 24 months to March have eroded wage gains, weighed on consumers and spurred a Federal Reserve response that has the potential to trigger a recession.

What generated the painful inflation, and what comes next? A review of the data reveals a situation that resulted from pandemic and government response disruptions, was aggravated by the war in Ukraine and is now cooling as supply issues resolve and the economy slows . But it also illustrates that today’s US inflation is starkly different from the price increases that first emerged in 2021, driven by stubborn price increases for services like airfare and childcare. of children rather than the cost of goods.

New wage and price data due out on Friday should show continued evidence of a slow and steady moderation in March. Fed officials must now judge whether the cooling is happening fast enough to assure them that inflation will soon return to normal – a target when the central bank releases its next interest rate decision on Wednesday.

The Fed is targeting 2% inflation on average over time using the Personal Consumer Expenditure Index, which will be released on Friday. This figure takes some of its data from the Consumer Price Index report, which was released two weeks ago and offered a clear picture of the recent trajectory of inflation.

Before the pandemic, inflation hovered around 2%, measured by the headline consumer price index and a “core” measure that excludes food and fuel prices to get a clearer picture of the trend. underlying. It fell sharply at the onset of the pandemic in early 2020 as people stayed home and stopped spending money, then rebounded from March 2021.

Some of that initial pop was due to a “base effect”. New inflation data was measured against the previous year’s pandemic-depressed numbers, which made the new numbers look high. But by late summer 2021, it was clear that something more fundamental was going on with prices.

Demand for goods was unusually high: Families had more money than usual after months at home and repeated stimulus checks, and they were spending it on cars, sofas and patio furniture. At the same time, the pandemic had shut down many factories, limiting the amount of supply global companies could produce. Shipping costs jumped, shortages of goods increased, and prices for physical purchases, from appliances to cars, jumped.

At the end of 2021, a second trend was also starting. Costs for services, which include non-physical purchases like tutoring and tax preparation, had started to climb rapidly.

As with the prices of goods, this is linked to strong demand. Since households were in good spending shape, landlords, child care providers and restaurants could charge more without losing customers.

Across the economy, companies seized the opportunity to boost their financial results; profit margins soared at the end of 2021 before moderating at the end of last year.

Companies were also covering their rising costs. Wages had started to climb faster than usual, which meant that companies’ payrolls were swelling.

Fed officials expected shortages in goods to ease, but the combination of faster inflation for services and accelerating wage growth caught their attention.

Even if wage gains had not been the initial cause of inflation, policymakers worried that it would be difficult for price increases to return to a normal pace with sharply rising wage rates. Companies, they believed, would continue to raise prices to pass on these labor expenditures.

Concerned central bankers began raising interest rates in March 2022 to dampen growth by making it more expensive to borrow to buy a car or house or expand a business. The aim was to slow down the labor market and make it harder for companies to raise prices. In just over a year, they brought rates to almost 5% – the fastest adjustment since the 1980s.

Yet at the start of 2022, Fed policy began to grapple with another force fueling inflation. Russia’s invasion of Ukraine in February caused food and fuel prices to spike. Between this and the rising cost of goods and services, headline inflation hit its highest level since the 1980s: around 9% in July.

In the months that followed, inflation slowed as increases in the cost of energy and goods subsided. But food prices continue to rise rapidly and, importantly, service cost increases remain rapid.

In fact, service prices are now at the center of the inflation story.

They may soon begin to fade in one key area. Housing costs have been rising rapidly for months, but rent increases have recently slowed in real-time data from the private sector. This should affect official inflation figures by the end of the year.

That left policymakers to focus on other services, which cover a range of purchases, including medical care, auto repairs and many vacation expenses. How quickly these prices – often referred to as “basic non-housing services” – can fall will determine if and when inflation can return to normal.

Now, Fed officials will have to assess whether the economy is about to slow enough to drive down the cost of these essential services.

Between central bank rate moves and the recent banking turmoil, some officials think that may be the case. Policymakers predicted in March that they would only raise interest rates once in 2023, a move widely expected at their meeting next week.

But market watchers will be listening intently when Fed Chairman Jerome H. Powell gives his post-meeting press conference. It could give clues as to whether officials think the inflation saga is headed for a quick conclusion – or for another chapter.

Ben Casselman contributed report.

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