US Consumer Inflation Falls to 6.5 per cent on Hawkishness

US Annual Inflation Falls to 6.5 per cent, Continuing Its Cooling Trend 

US Retail Inflation tapers on Fed hawkishness

December 2022 marked the sixth consecutive month of lower consumer inflation in the US. From the peak of 9.1% in June 2022, the US consumer inflation has now fallen 260 basis points to 6.5% in December 2022. To a large extent, the incessant hawkishness of the Fed has helped rein in inflation. The US Fed rates are now a full 425 basis points higher than what there were in March 2022. Powell has indicated about toning down hawkishness but then most of the rate hikes have already been front-ended. This has constricted consumption and had an impact on inflation. The current Fed rate is about 200 bps above the neutral rate, which means even a 25 bps hike from here would have an oversized impact on inflation. Here is the US inflation story for December 2022.

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How the US inflation traversed 260 bps from the peak?

After the consumer inflation in the US had scaled up to 9.1% in June 2022, it has been on a steady downward trend. Since June, inflation has gradually tapered to 8.5%, 8.4%, 8.2%, 7.7% and 7.1% between July and November. In December 2022, consumer inflation fell by another 60 bps to 6.5%. what led inflation lower? In December 2022, there was a sharp fall in energy inflation, while food inflation and core inflation has fallen to a lesser extent. That is evident from the table above. Food inflation fell 20 bps from 10.6% to 10.4%. On a MOM basis, energy inflation fell 580 basis points from 13.1% to 7.3% while core inflation fell by 30 bps from 6.0% to 5.7%.

Breaking up the fall in US inflation in December 2022

Before we go to the components of the fall in inflation, here are some key risk factors to energy prices. There is a growing concern that a recovery in China post-COVID relaxations could boost crude oil prices, and that is already partially evident. In addition, the total EU ban on Russian diesel imports will kick in 20 days from now and that could also prop up the price of crude oil. In other categories of inflation, food inflation fell yoy, but remains 0.3% higher on a sequential basis. While prices of vegetables and fresh fruits tended lower, high protein items like meat and eggs saw a spike in inflation. There is also an interesting trend in core inflation. While the overall core inflation has tapered, the dichotomy is that product related core inflation is tapering, but services related core inflation is still rising.

Where do Fed rates go from these levels?

The fall in inflation in December is largely along expected lines and so there unlikely to be any change in the Fed stance. Fed has already underlined that it would not give up on its inflation battle till the time consumer inflation was firmly on the road to 2%. With Fed having hiked rates by 425 bps, headline inflation is down by 260 bps. However, from here on, the lag impact on inflation is likely to be quite rapid. Here is the guidance.

1. Fed is likely to hike rates by another 75 bps in 2023. However, as per the latest minute, this would be in 3 tranches of 25 basis points each.
2. Rate cuts for the year 2023 are largely ruled out and any rate cut would be conceivable only in the year 2024. That would still depend on how the GDP pans out in 2023.
3. The Fed expects inflation to be reined in with higher rates, but there could be two major concerns here. First is the rapid opening of the Chinese economy and the second is the oil shortage created by the full embargo by EU on Russia. 

The good news for the RBI is that it has largely been in sync with the Fed on hiking rates, so the risk of monetary divergence is quite low. One thing is clear. In the coming months, the US Fed and the RBI would gradually attempt to change the colour of their intervention away from inflation and more towards facilitating growth. That is the good news!