Breaking news: CPI sees largest increase since 1981

U.S. inflation accelerated dramatically during June 2022 according to the latest data from the Bureau of Labor Statistics. On a month-over-month basis, consumer prices increased by 1.3%. On a year-over-year basis, prices are up by 9.1%, the largest annualized increase in prices since November 1981.

Core inflation—which strips out volatile food and energy prices—increased by 0.7% on a monthly basis in June, up from 0.6% in May. Core inflation is particularly important as it tends to be predictive of future inflation. Outside of the core categories, gasoline prices increased by 11.2% on a monthly basis and 60.6% on an annualized basis.

In addition, shelter inflation—which includes residential rents and makes up a large chunk of the overall inflation index—continued to accelerate to 5.5% on a year-over-year basis. The shelter component is something of a puzzle because according to most third-party real estate data providers, actual rental rate growth in the U.S. is still close to or above 10%. It is possible that the BLS is collecting the residential rent data at a significant lag, which would imply even higher shelter inflation readings in the months ahead.

All in all, today’s inflation report was cold comfort for those expecting a steep drop in inflation. Some of the price growth reported today was expected since the data was collected during the period when gas prices were at their highest (they have since come down significantly). We still see inflation slowing through the remainder of the year based on the recent easing in supply chains, falling energy prices and an expected slowdown in the U.S. labor market.

Following today’s inflation report and recent commentary from the Fed Chairman Powell, our interest rate forecast is almost entirely driven by the monthly inflation readings. The Fed is clearly more tolerant of recession risk than normal in favor of reducing the rate of inflation in order to return price stability. However, even if a recession is triggered by the current and expected rate hikes, there is every reason to believe that it would be a moderate downturn. With these factors in mind, we project the Fed to raise interest rates by another 75 basis points at both of its upcoming meetings in July and September. With the economy slowing further into the third quarter, we expect the Fed to raise rates by 25 basis points at each of the remaining three FOMC meetings in 2022.

A hawkish Fed will constrain economic growth to some extent by weakening demand and tightening financial conditions. However, it remains unclear to what extent the current rate hikes will have on the major sources of inflation: rising oil prices, supply chain bottlenecks, labor constraints and residential rent growth.  At the same time, oil prices are moderating, supply chain stress is easing and we have some tentative signs that the red-hot labor market is starting to cool. These trends may allow the Fed to slow the rate of interest rate hikes earlier than anticipated.