Stubborn Inflation Poses Risk to Recently Upgraded US Forecasts for Economic Growth

So far, 2024 isn’t going quite how it was supposed to for the US economy: Inflation has been higher than expected and household spending seems to have lost some momentum.

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Bloomberg News

Matthew Boesler

Published May 12, 20244 minute read

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(Bloomberg) — So far, 2024 isn’t going quite how it was supposed to for the US economy: Inflation has been higher than expected and household spending seems to have lost some momentum.

Those trends represent a new risk for economic growth forecasts that were upgraded around the turn of the year, largely on the view that rapid disinflation would help bring about rising real incomes and lower borrowing costs.

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Two key reports due Wednesday, on consumer prices and retail sales, will give an indication of how real the threat is to the outlook. Payroll and wage growth slowed in April, and without a corresponding cooldown in price increases, families’ budgets will come under further strain.

“If inflation remains sticky, that actually introduces significant downside risks to the growth outlook because labor markets aren’t in the same place,” said Neil Dutta, head of US economics at Renaissance Macro. “You’re going to have to start worrying about what that means for real incomes.”

Consumer prices excluding food and energy rose at a 4.5% annualized pace in the first three months of 2024, a step up from the 3.3% annualized increase in the fourth quarter. Retail sales, meanwhile, were up just 0.4% in the first quarter after adjusting for inflation, according to a Bloomberg Economics estimate, compared with the 2.9% increase that closed out 2023.

In April, economists expect monthly inflation to step back down to a pace more in line with the end of 2023, while they see growth in retail sales, which aren’t adjusted for inflation, slowing.

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Forecasters are typically reluctant to revise their outlooks after just a handful of surprises, but there are signs that doubts are starting to creep in after three successive months of higher-than-expected inflation figures. Consumers may have taken their cue from the reports, with year-ahead inflation expectations moving up in recent University of Michigan surveys.

Federal Reserve Chair Jerome Powell, speaking after the US central bank’s latest policy meeting on May 1, said officials “don’t like to react to one or two months’ data, but this is a full quarter and I think it’s appropriate to take signal now.”

At that meeting, Fed officials kept interest rates at the highest level in more than two decades, where they’ve been since July.

Read More: US Week Ahead From Bloomberg Economics: CPI, PPI, Retail Sales

Economists at S&P Global Market Intelligence said in a May 9 report that they were making slight downward adjustments to their estimates for growth in 2025 and 2026, thanks to a later start for Fed rate cuts.

That’s why so much is riding on the data due this week, especially amid signs the labor market is cooling. A monthly employment report published on May 3 showed average hourly earnings rose just 2.8% annualized in the three months through April, the least since the first quarter of 2021. And a widely-followed leading indicator of wages — the quits rate — points to more deceleration ahead.

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Meanwhile, excess savings accumulated during the pandemic — another major driver of consumer spending in recent years — may finally have been exhausted as of March, according to a recent San Francisco Fed estimate.

There are good reasons to think the recent uptick in inflation is set to reverse in the coming months. One of the main culprits behind the elevated figures in the consumer-price index has been a slower-than-expected pace of moderation in rental inflation. That indicator tends to lag, in part because changes are reflected in the official data only when people move or renew their leases, and should soon start following measures of current rents lower.

Read More: Rents Set to Be Last Domino to Fall in Global Inflation Battle

The other major factor was a surge in motor-vehicle insurance costs, which economists also expect to eventually slow. Forecasters don’t see rising housing and insurance costs as reflecting an increase in underlying demand — meaning they’re not threatening to further heat up inflation.

“Car insurance surprised us to the upside last print, but we don’t see evidence of structural changes pointing to a sustained acceleration,” a team of Morgan Stanley economists led by Ellen Zentner wrote in a May 9 preview of the inflation numbers.

“In fact, we think higher profitability in the sector will make insurance companies pivot to a more growth-focused strategy, implying lower car insurance inflation ahead,” they said.

That would be welcome news for consumers who have increasingly been tapping into their savings. Growth in personal consumption expenditures in the first quarter was propelled in large part by a decline in the saving rate, which fell in March to a 17-month low.

“You really need to see the weaker inflation numbers to maintain the good story for the consumer,” Dutta said.

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