IS US INFLATION AT A PEAK?

24.06.2022 Following this month’s three quarters of a percentage point interest rate rise we look at the outlook for US inflation below.

Much of US inflation, currently 8.6 percent on an annual basis, is externally generated. Indeed, only around one third is domestically generated service sector inflation. The service encompasses items that are not manufactured such as healthcare and entertainment. In contrast around two thirds is explained by global factors such as the war in Ukraine and disruptions to worldwide manufacturing supply chains.

Whilst food price inflation will likely continue to rise, as higher grain prices feed through into processed food prices, the outlook for the other main components is more encouraging.

Oil prices have fallen back this month as markets have reacted to an expected slowdown in global growth. A stabilization at these levels would remove around two percentage points from the US inflation rate over the next year.

The outlook for goods price inflation is also improving. Higher prices for manufactured goods were caused by extraordinary demand, as consumers spent some of their savings accumulated during lockdown, as well as Covid related disruption of supply chains. Looking forward demand should start to normalise, due to the rising cost of living, while supply chains in advanced economies are also beginning to improve as Covid ‘herd immunity’ emerges. However further progress is conditional on the lifting of current Covid lockdowns in China.

Service sector inflation is currently contributing around three percentage points to the annual inflation rate. This reflects very strong demand at the end of last year and also a tight US labour market. As the impact of higher interest rates begins to slow growth it is reasonable to expect service sector inflation to begin to moderate towards the end of 2022.

So, given the prospect of reduced inflationary contributions from three out of the four component categories it looks like US inflation is at, or close to, a peak. Confirmation of this, in the actual inflation data, would be very positive for both bonds and equities.

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This post was written by Robin