The Fed is at a crossroads

February data on US inflation further complicated the prospects for the completion of the US Federal Reserve’s monetary tightening cycle. Core inflation increased by 0.5% over the month, in annual terms, the indicator slowed down minimally, from 5.6% to 5.5% – such dynamics indicates the risks of maintaining high prices. The Fed is in a difficult situation – the fight against inflation requires the regulator to tighten its policy, but the fall of a number of banks that happened last week, on the contrary, calls for soft actions to maintain financial stability.

Consumer inflation in the US in February slowed down from 6.4% to 6%, month-on-month growth was 0.4%, according to data from the Bureau of Labor Statistics. Energy prices fell again month on month – by 0.6%, their annual growth slowed down to 5.2%. Food prices rose by 9.5%, for the month – by 0.4%.

Analysts were worried about core inflation in the United States (excluding food and energy prices) – its growth accelerated to 0.5% in February (to a maximum since September), while the annual rate slowed slightly – from 5.6% to 5.5%. The acceleration of core inflation is evidence of continued price growth, despite the reduction in the cost of energy, according to Capital Economics. Rising clothing prices, as well as an expected reversal in the decline in used car prices, also do not contribute to lowering expectations. In the services sector, growth accelerated to 0.6% mom, including the cost of renting housing increased by 0.8% (in annual terms – by 8.1%), transport services – by 1.1% (plus 14, 6%).

Slower-than-expected rates of inflation are putting additional pressure on the Fed, as the regulator has been trying for a year to achieve a steady slowdown. Inflation began to accelerate against the background of the economic recovery after the pandemic (at the end of 2021, the figure was 7%), but at that time the price increase was considered as a temporary effect of a break in supply chains, an imbalance in supply and demand, and a recovery in commodity prices. The economy, according to the Fed, was under the negative influence of the consequences of the pandemic.

New risks, including those associated with rising energy prices after the start of military operations in Ukraine, forced the Fed to conduct a cycle of rapid monetary tightening last year. The rate began to rise in March, but at the last FRS meeting it raised it to the level of 4.5-4.75%, which was the maximum since 2007. It was assumed that a quick rate increase would minimize losses for the economy – here the Fed could refer both to the experience of previous rounds of fighting inflation (a slower reaction of the regulator could lead to a change in inflation expectations and consolidation of higher price growth as a new norm), and to current macro statistics – all last year it pointed to the risks of “overheating” in the labor market: unemployment remained steadily low, and wages grew.

Back in early February, this plan looked quite realistic – analysts were optimistic and expected a stable slowdown in inflation and no more than one rate hike (in March). But comments by Fed Chairman Jerome Powell and inflation data have raised new concerns – the regulator’s rhetoric has again become tough, and the end of the cycle has been pushed back to a later date. Now, the end of the cycle in March (as well as the second rate increase, but by no more than 0.25 points in May) looks more realistic, despite the persistence of high prices. The regulator is forced to balance inflationary risks with sudden risks to the financial stability of the banking sector due to the bankruptcy of Silicon Valley Bank (SVB) – this policy was previously typical of the ECB, whose ability to raise rates is limited by the consequences for issuers of so-called peripheral securities. However, the crisis around SVB also led to a significant adjustment in oil prices – already by the end of March, the cost of energy in the United States in annual terms may show not an increase, but a decrease, Capital Economics expects.

Tatyana Edovina