- Americans are experiencing higher living costs in 2018
- Rising energy prices are partly to blame
- Escalating trade tensions could translate to higher prices for consumers
If you feel as if life has become more expensive in recent months, you are not mistaken. The Consumer Price Index (CPI) rose at a 2.8% pace for the twelve months ending in May.1 The country hasn’t seen such a steep price increase over a 12-month period since early 2012.2
The more important question is whether this uptick in inflation is a cause for concern. At face value an inflation rate of 2.8% may seem relatively benign, especially to those who remember the double-digit inflation rates of the late 1970s. However, it is up significantly from last June, when it rose just 1.6%.1
The country hasn’t seen such a steep price increase over a 12-month period since early 2012.2
What’s driving the rise in inflation?
The pickup in the overall rate of inflation in the past twelve months is primarily attributable to the recovery in energy prices, which climbed at a 11.7% rate3 over the same period. In May 2017, the price of a barrel of West Texas Intermediate crude oil was nearly $50. This May that same barrel cost substantially more — $70.3
Translating those prices to what you’d pay at the pump, one year ago last spring the national average price for a gallon of unleaded gasoline was $2.26. Fast forward to this June, it was $2.85. By Independence Day, it had risen even more to $2.96.4
More than just gas prices
Energy prices, as well as food prices, can be quite volatile. In order to eliminate the distortions that such volatility can create, and get a clearer picture of the underlying trend, the Labor Department removes the food and energy categories to calculate what it calls the “core” inflation rate.
In May, the core rate rose by 2.2%, slightly slower than the so-called headline CPI rate of 2.8%. Other major categories driving the year-over-year inflation rate increase were: 1
- Cost of shelter, representing almost one-third of the overall CPI, rose by 3.5%
- Medical care services, with an almost 7% weight, rose by 2.3%
- Transportation services, making up 4% of CPI, rose 3.8%
The impact of a red-hot job market
In some respects, it is surprising that the inflation rate is not accelerating even faster. There is a long-held belief among economists that falling unemployment results in rising wages, pushing the core inflation rate higher.
The national unemployment rate fell to 3.8% in May, well below the roughly 4.5% level at which the Federal Reserve has anticipated that wage inflation would begin to accelerate.5 But so far, for reasons not fully understood, that has not happened.
Some reasons employers have been able to keep wage increases modest include:
- An increasing rate of retirement among higher paid baby boomers
- A less mobile labor force
- Lackluster improvement in the nation’s productivity
Average hourly earnings rose by just 2.7% in the past year, slightly below the rate of inflation. However, this rate may increase as the labor market tightens and demand for workers increases. The Atlanta Federal Reserve’s Wage Growth Tracker tool shows a three-month moving average of wages growing at a faster 3.2% rate in May.6
If the economy keeps expanding as we expect, and the labor market continues to tighten, we anticipate that wages should begin to rise at a somewhat faster pace.
The Fed moves slow and steady in raising interest rates
In efforts to normalize monetary policy and prevent inflation from accelerating as the economic expansion continues, the Fed has been raising interest rates. But while inflation has risen faster over the past year, by historical standards the level of increase is modest. This pace has allowed the Fed to proceed slowly and keep the economy on a stable course.
Recently the Fed has indicated its willingness to let inflation rise modestly above its 2% inflation target for a short time to make sure that a period of disinflation (a reduction in the rate of inflation), or even outright deflation (a period when prices are declining, typically a sign of a struggling economy), does not reappear. During the last recession in 2008-09, there was a fear that we may have been at risk of experiencing deflation.
The trade wildcard and consumer prices
The recent escalation in trade tensions between the U.S. and its major trading partners could also contribute to higher prices. This is especially likely if the imposition of tariffs and retaliatory responses expand beyond their current limited scope.
Imports by the U.S. represent 15% of economic activity, and higher prices due to tariffs would surely impact consumers.7
What’s ahead on the inflation front
Prices are rising just enough to draw consumers' attention, particularly at the gas pump. While the inflation rate is up, the increase remains moderate by historical measures.
We anticipate that inflationary pressures will increase as the demand for workers continues to match or outpace the number of Americans looking for work. This has the potential to create a risk that the cost-of-living could be in for faster increases. However, we expect only modestly higher inflation over the course of this year and next.