Inflation's stall isn't a seasonal fluke

For the first months of 2024, commentators blamed sticky inflation on leftover January seasonal effects and quirks in contract resets. The February core PCE price index put an end to that comforting story. It rose at an annualized rate of 2.8 per cent. Disinflation has stalled, and seasonality does not explain it.

How the excuse took hold

The hot readings began with January's consumer-price report, published in mid-February, which showed core prices rising 0.4 per cent in a month. Many economists put it down to January effects: firms reset prices at the start of the year, and seasonal adjustment has struggled to strip that out since the pandemic. The explanation was plausible, and there was precedent for it, since January 2023 had also run hot. It predicted that February would cool.

February did not cool. Core consumer prices rose another 0.4 per cent on the month, lifting annual core inflation on that measure to 3.8 per cent, and the Fed's preferred gauge confirmed the picture at the end of March. Two strong months in a row are difficult to dismiss as a calendar quirk.

Services refuse to cool

Prices for services outside housing, along with domestic wages, are still rising at rates that do not fit the Federal Reserve's two per cent target. Consumer spending has held up and financial conditions are unusually loose, so companies can still pass higher input costs on to customers. The last stretch of the fight against inflation is turning into a long siege, and nothing about it looks immaculate.

Some of the stickiness sits in prices that reflect costs incurred years earlier. Car insurance premiums have risen by about a fifth over the past year, as insurers pass on the higher cost of repairs, replacement parts and vehicles that built up during the pandemic, and because regulators in many states must approve rate increases, premiums respond to costs with a long lag and are still catching up. Medical services prices, often set in multi-year contracts and by government reimbursement formulas, adjust slowly in the same way. Lags of this kind mean inflation can keep running above target for months after the original shock has faded, long after the goods prices that started it have settled. That is persistence of a kind no seasonal factor can remove, and it is concentrated in exactly the services categories the Fed watches most closely.

Why demand has not cracked

The mechanism behind persistence is demand that tighter policy has not dented. The economy grew at an annualised rate of 3.4 per cent in the fourth quarter, far above most estimates of its trend. Household incomes have been supported by a strong labour market and, for older savers, by interest income on cash that now pays above 5 per cent. Many homeowners locked in low fixed mortgage rates in 2020 and 2021, so higher rates have not raised their monthly payments. The share prices of big technology companies have lifted household wealth. Each of these blunts the effect of a high policy rate.

Financial conditions matter too. Stocks have repeatedly hit records this year, corporate credit spreads are narrow, and companies have found it easy to issue debt. When borrowing is cheap in markets and asset prices are rising, firms can pass on higher wages and input costs with less fear of losing customers. Oil prices have also climbed since the start of the year, which feeds into transport and delivery costs across the economy.

The transitory lesson

The Fed has been through a version of this before. In 2021 officials and many forecasters described rising inflation as transitory, the result of supply bottlenecks that would soon clear. Some of the bottlenecks did clear, but inflation broadened and the Fed was forced into the fastest tightening in four decades. Attributing today's stall to seasonality carries the same risk: an explanation that justifies waiting can delay recognising a problem until it is harder to fix.

Who pays if the stall lasts

Borrowers on floating rates, from credit-card users to companies with leveraged loans, will keep paying current rates for longer. Homebuyers face mortgage rates that remain close to 7 per cent. Holders of long bonds face losses if markets have to push their expected rate cuts further out. Savers in money-market funds are the winners, collecting high yields for longer. Equity investors who have priced in several cuts this year are the most exposed to disappointment.

The case for patience

The counterargument deserves a hearing. Annual core PCE inflation has still fallen a long way from its peak, and at 2.8 per cent it is well within reach of the target. Rents on new leases have slowed, which will pull shelter inflation down through the year. Wage growth is easing, and immigration is expanding the supply of workers, which should restrain pay. The Fed's March projections still showed three cuts this year, suggesting that officials see the recent readings as a bump.

That argument may prove correct for the year as a whole. But the Fed has said it needs greater confidence before cutting, and two or three months of firm data make that confidence harder to reach. The indicators to watch are March's consumer-price report, due on 10 April, the March jobs report this week, and core services inflation excluding housing.

The seasonal excuse was always too convenient. Prices keep rising because demand has barely felt tighter policy, and the Fed will probably keep rates high for longer than markets hoped, with a first cut before the summer now unlikely.