Inflation is continuing to ease, albeit slowly. Based on the latest US Consumer Price Index report released Wednesday, inflation now sits at 3%, meaning that the overall measure of prices for a broad range of goods and services is 3% more than a year ago.
Though analysts see it as a positive forecast amid protracted warnings of a severe economic downturn, prices are still rising at a pace that’s higher than the Federal Reserve’s 2% annual target rate.
Since early 2021, everyday essentials, from groceries to gas, have become more expensive, reaching a record-high inflation rate of 9.1% in June 2022. Earlier last year, the Fed began aggressively raising interest rates in an attempt to slow down the economy and curb prices by reducing consumer borrowing. After 10 consecutive rate hikes, the Fed took a pause in June, a signal that inflated prices might finally be declining.
“The CPI report for June indicates that inflation is coming down,” said Dawit Kebede, a senior economist from Credit Union National Association. “This includes prices for core services, excluding shelter, which the Federal Reserve closely monitors.” Housing costs, which account for around a third of the overall index, are rising at an annual rate of 7.8% and continue to be a principal driver of inflation.
Despite the economy cooling, prices are still high, rates for borrowing are still taking a toll on US households and consumers feel pressed. Here’s a quick primer on the state of inflation and steps you can take to prepare for what’s ahead.
What is inflation?
Inflation means your dollar bill doesn’t stretch as far as before, whether at the grocery store or a used car lot. “Inflation refers to the increase in the prices of goods and services over time,” said Xavier Epps, CEO of XNE Financial Advising.
Inflationary pressures happen over time and require historical context to understand. For example, in 1993, the average cost of a movie ticket was $4.15. Today, watching a film in the theater will easily cost you $13 for the ticket alone, never mind the popcorn, candy or soda. A $20 bill 30 years ago would buy someone more than double what it buys today. And while wages have also risen over the past few decades, they haven’t kept up with inflation. Consumers have less purchasing power.
That becomes a concern when high prices are out of control and require a slowdown of economic activity to tame them, which can sometimes, though not always, trigger a recession.
What does the latest CPI report reveal?
Core inflation (which excludes the volatile prices of food and energy) hit 4.8% in June, increasing by 0.2% month over month. “This represents the smallest one-month increase in core prices in nearly two years,” said Kebede.
That’s a lower inflationary rate thanks to decreased prices in a few key categories, such as airfare, communication, household furnishings and used vehicles. Yet the price indexes for shelter, motor vehicle insurance, apparel, recreation and personal care all went up.
The easing is greater than expected, according to Michael Ashley Schulman, chief investment officer at Running Point Capital Advisors. But that doesn’t mean inflation will reach the Fed’s 2% target anytime soon, Schulman added.
How do we know we’re in a period of high inflation?
Inflation affects everyone differently, and it’s not determined by observation. It’s backed by a consensus of experts who rely on market indexes and research.
One of the most closely watched gauges of US inflation is the Bureau of Labor Statistic’s CPI, which tracks data on 80,000 products, including food, education, energy, medical care and fuel. The BLS also puts together a Producer Price Index, which tracks inflation from the perspective of the producers of consumer goods, measuring changes in seller prices in industries like manufacturing, agriculture, construction, natural gas and electricity. There’s also the Personal Consumption Expenditures price index, a broader measure prepared by the Bureau of Economic Analysis, which includes all goods and services, whether they’re bought by consumers, employers or federal programs on consumers’ behalf.
The current inflationary period started back in April 2021, when consumer prices jumped at the fastest pace in over a decade, causing a stir among market watchers. Inflation was originally thought to be temporary while economies bounced back from COVID-19. But as months progressed, supply chain bottlenecks persisted and prices skyrocketed. The US was then hammered by unanticipated shocks to the economy, including subsequent COVID variants, lockdowns in China and Russia’s invasion of Ukraine, leading to a choked supply chain and soaring energy and food prices. The cost of gasoline prices was a big contributor to inflation in 2022.
After reaching a peak rate of around 9% last summer, inflation has now dropped to 3%. Although that’s still high, Schulman believes we’re in a state of “stayflation,” where inflation will remain in the 3% to 4% range unless there’s an official recession.
How are the Federal Reserve’s rate hikes tied to inflation?
In March 2022, after the CPI reached 8.5%, the Fed initiated its first in a series of rate hikes.
“As inflation rises, the Fed has to try to control it. Really, the only tool that the Fed has in order to do that is raising policy rates,” said Liz Young, head of investment strategy at SoFi.
The Fed moderates inflation and employment rates by managing the money supply and setting interest rates, and part of its mission is to keep average inflation at a steady 2% rate. When the Fed increases the federal funds rate — the interest rate banks charge each other for borrowing and lending — it restricts how much money is available to borrow and spend, which has an impact on economic growth. Banks pass on rate hikes to consumers, meaning everything from credit card APRs to interest rates on personal loans tick up. Consequently, this can drive consumers, investors and businesses to pause their investments, leading to a rebalance in the supply-and-demand scales.
In general, when interest rates are low, the economy and inflation grow. And when interest rates are high, the economy and inflation slow.
Now, with inflation cooling down, experts are split on what the Fed will do at the subsequent Federal Open Market Committee meeting on July 26. Some experts, including Kebede, believe the latest CPI report gives the Fed enough reason to hold rates where they are for now.
But Schulman believes the Fed will raise its federal funds rate by 0.25% at the FOMC meeting. “Inflation that still remains above their 2% target and the strong US economy emboldens the Federal Reserve to tighten policy further,” he said.
What does inflation mean for you?
Periods of high inflation make it harder to afford everyday essentials. Interest rate hikes mean it costs more for businesses and consumers to take out loans, so buying a car or home gets more expensive. As interest rates increase, liquidity in securities and cryptocurrency markets decreases, causing those markets to dip. Credit card debt and other forms of high-interest debt have also become more expensive over the last year.
Though inflation has been easing for the past few months, there’s no guarantee that it will continue to trend downward, and there’s still a chance of more Fed rate hikes this year.
In the current period, experts recommend trying to chip away at debt the best you can. One option is a debt consolidation loan that could combine any high-interest variable debt into a lower-interest, fixed-rate loan, and establishing a payoff plan. Getting a balance transfer card can also help you avoid high interest for a period of time. If the economy continues to be volatile, it’s also important for households to build up a financial cushion.
While inflation has been stubborn, there’s one financial advantage to increased rates: Many CDs, high-yield savings accounts, money market accounts and treasury bonds are offering annual percentage yields, or APYs, at around 4.00% — the highest savings rates seen since the 1990s. Experts recommend taking advantage of putting your funds in one of these accounts to get a bigger return on your balance. The interest you earn can help you reach your emergency fund or sinking fund goal faster.
