Slow & Steady

Inflation has dropped to two-year lows. Will the race be won in 2024?

There was much optimism in the early months of 2021 as Covid vaccines became widely available, countries reopened their borders, and business as not-quite-usual began again in earnest. But the world economy had suffered quite a jolt with the pandemic, and starting back up again was not as simple as a flip of a switch. Companies were scrambling to remake frayed supply chains on the fly. While economic stimulus packages did a good job of keeping Americans afloat, the goods they were buying from overseas were stuck in or just outside of overwhelmed ports. With the world firing back up, energy prices soared, making it much more expensive to fill a gas tank than it had been a few months prior. Inflation was the word on everyone’s lips, and the Federal Reserve set about steadily hiking interest rates in its goal to bring inflation levels down to 2%, even if it meant slowing the economy to do so. Seeing a rare chance, companies set about raising their prices to boost profits, making just about everything cost a little more. Inflation persisted.

But eventually, the tide started to turn. Inflation, while certainly much higher than the Fed’s 2% goal, started to decrease. In August, core inflation (i.e., discounting the food and energy sectors) hit 3.9%, the first time since June 2021 that it was below 4%. Core inflation ticked back up to 4.1% in September, but overall inflation was at 3.7% as energy prices dipped from their summertime highs. What was once a 40-year-high inflation rate of over 9% was now much more manageable. The Fed, which raised interest rates 11 times in just over a year, left rates steady at its last two meetings. U.S. GDP grew at a startling 4.9% annual clip in the third quarter, leaving Fed chair Jerome Powell confident that inflation can continue dropping as the economy grows.

“The good news,” Powell said, “is we’re making progress. The progress is going to come in lumps and be bumpy, but we are making progress.”

Rates Remain High

Powell left open the possibility that rates could go up after the Fed’s December meeting. He indicated that holding steady gives the central bank time to assess the economy’s health and the direction it’s heading.

“Slowing down,” Powell said, “is giving us a better sense of how much more we need to do, if we need to do more. That’s the question we’re asking: Should we hike again?”

Even if interest rates don’t go up, it’s unlikely they’ll go back down again anytime soon. Atlanta Fed president Raphael Bostic indicated rates will remain in the 5.25-5.5% range for much of 2024.

“I think our policy is sufficiently restrictive to get to our 2% target,” Bostic told reporters in early October. “My next decision is not when to cut, but how to assess how rapidly the economy will move to 2%, which is more about monitoring the degree of slope and slowdown and what’s happening on supply side and whether (it’s) moving in ways that allow businesses to respond to elevated demands.”

He and other Fed officials don’t envision reaching that 2% target until the end of 2025. If that’s true, interest rates will stay at or near their highest levels in more than two decades for some time to come.

While that has not done much yet to cool off a hot economy undergoing a post-pandemic boom, it remains to be seen what effect another two years of high rates might have.

Still Some Turbulence

Inflation deceleration is not exclusive to the U.S. In October, inflation in the euro zone dipped to 2.9%, marking its lowest point since July 2021. The European Central Bank is even contemplating the potential for an interest rate cut next year if inflation remains below 3%. However, the ECB does not anticipate a return to 2% inflation before 2025, even as the euro zone’s economy experienced a minor contraction in the third quarter. Notably, Germany, the largest economy within the euro zone, recorded a two-year low in inflation at 3% in October. In Japan, the inflation rate reached 3% in September, marking its lowest level in a year.

Inflation’s easing doesn’t mean things are cheap, however. It just means that the rate at which costs rise is decreasing.

“Inflation is easing; it’s edging lower. However, food and energy prices remain elevated, and the average American lives in an environment in which food and energy are basics for their budget. And that budget is climbing higher,” Quincy Krosby, chief global strategist for LPL Financial, told NBC News.

With inflation declines in 14 of the last 16 months, however, the situation is certainly much improved from those soaring prices that came along with hot vax summer and clung on as an uninvited guest, growing larger and larger for nearly a year and threatening to drag the U.S. into recession.

That progress has been bumpy, and as Powell noted, will continue to be so.

“I still believe, and my colleagues for the most part still believe, that it is likely to be true … that we will need to see some slower growth and some softening in the labor market to fully restore price stability,” Powell said.

Skies are blue for now, but the economy could still hit some turbulence as it seeks a soft landing.