MW Five things we've learned this week about inflation - and why it's so hard to kill the beast

By Jeffry Bartash, Greg Robb and Tomi Kilgore

Fed effort to restore price sanity suffers setbacks

A rebound in U.S. inflation since the autumn has stunned investors, scuttled Federal Reserve plans to cut interest rates and even raised questions about whether the central bank is losing the battle.

Below are five things we have learned from the main inflation readings this week on consumer and wholesale prices.

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A strong economy is inflationary

The traditional central-bank method to reduce inflation is to lift borrowing costs enough to depress consumer demand, raise unemployment and weaken the economy.

That's what the Fed did. The bank jacked up interest rates sharply in 2022 and 2023 to try put the inflation genie back in the bottle.

'In this type of economy, to run the last laps on disinflation is really, really hard.'Brian Bethune, Boston College

And, for the most part, the strategy worked. The rate of inflation using the consumer-price index slowed to 2.4% last September from a 40-year peak of 9.1% in the middle of 2022.

What higher rates didn't do - much to everyone's surprise - is to slow consumer spending and, as a result, the economy. Both spending and gross domestic product grew faster, and unemployment has remained extremely low at 4%.

The upshot: Since September the annual inflation rate has crept back up to 3%.

The economy may be running too hot, economists say, to allow inflation to return to low prepandemic levels of 2% or less.

"We have an economy that is running at 'full tilt,' " said Brian Bethune, an economics professor at Boston College. "In this type of economy, to run the last laps on disinflation is really, really hard."

Services are expensive

Americans aren't spending as much on goods such as new cars or appliances, even though prices have fallen lately. They sure are spending a lot of money on services, though.

Fun stuff like vacations, travel, recreation, personal care and the like, that is. Or necessities such as rent, car repairs and insurance.

The demand for services means service inflation is running well above normal - 4.3% in the past year if energy is excluded. These costs rose 2% to 3% a year in the decade before the pandemic.

High interest rates orchestrated by the Fed to tame inflation don't affect the prices of services much. People don't take loans to go out to dinner or get on a plane.

Until this demand tapers off, it's going to be hard for the Fed to get inflation back down to 2%.

Inflation in the pipeline

Higher costs of raw materials are working their way through the economic pipeline and suggest inflation won't ease as rapidly as the Fed had hoped.

The wholesale cost of raw materials, for instance, surged 5.5% in January. And they are up almost 9% in the past year.

Higher oil prices have driven the recent increase, but cocoa prices just hit a record high, and the costs of wheat, corn, soy and other staples are still well above prepandemic levels.

New tariffs on steel and aluminum, meanwhile, have spurred U.S. metals producers to raise prices, potentially adding to inflationary pressures.

Tariffs are not a big problem - yet

Trump's threats to raise most tariffs has put businesses on edge since that could result in higher prices for their supplies, many of which come from overseas.

Businesses say it's not a problem yet, but they are watching the White House's actions closely.

The "situation is certainly fluid, and we continue to monitor changes in policy as they occur," said Josh Jepsen, chief financial officer at Deere & Co. (DE), in a conference call with investors. "Teams across the organization are continually running potential scenarios to understand risks."

January is the worst month to judge inflation

Businesses don't like to irritate customers by raising prices constantly. Many companies raise prices just once a year, typically in January.

The result: Inflation would look sky-high in January if the government did not make so-called seasonal adjustments to account for this phenomenon.

What do government economists do? They try to adjust for the January price increases as if they had taken place over a full year.

When they get these adjustments wrong, inflation can look a lot worse in January than it is in reality. Economists call it "residual seasonality."

All investors need to know, though, is that inflation readings in January can be misleading. Prices rose sharply in January in each of the past three years, for instance, only for inflation to slow in the following months.

That's why the next few months of inflation data are critical.

"While there isn't a definite case for inflation climbing again," said senior economist Elizabeth Renter at NerdWallet, "it's also becoming more difficult to say that it's moving in the right direction."

-Jeffry Bartash -Greg Robb -Tomi Kilgore

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February 13, 2025 14:55 ET (19:55 GMT)

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