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Inflation continued to fall in March as energy prices fell from a year earlier when they started to rise due to the Russian invasion of Ukraine.
But fluctuations in gasoline and other energy masks are masking price pressures, which are easing but remain below the surface, economists said.
“It’s improving and the economy is cooling, but it’s far from lukewarm,” said Diane Swonk, chief economist at KPMG, of inflation.
The consumer price index, a key indicator of inflation, rose 5% in March from 12 months earlier, the US Bureau of Labor Statistics said on Wednesday.
The index measures price changes across a broad basket of consumer goods and services, such as groceries, housing, electronics and leisure.
The most recent annual reading declined from 6% in February. The drop doesn’t mean prices have fallen; they’re still rising, just slower than a year ago.
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A bit of inflation is good — policymakers are targeting a different but related metric at around 2% per year.
Although inflation is still “painfully high,” it has eased significantly from its peak of more than 9% in June 2022, said Mark Zandi, chief economist at Moody’s Analytics. Inflation appears poised to fall back towards policymakers’ target by this time next year barring unforeseen derailments, he said.
“Inflation is basically slowing down,” Zandi said. “And all trend lines are looking good.
“I can say that with growing confidence.”
What is driving inflation in March 2023
According to the BLS, housing construction was a “notable” driver of inflation in March and last year.
The housing index rose 8.2% last year and accounted for over 60% of total consumer price inflation after excluding volatile energy and food categories. Other notable annual increases include auto insurance (15%), household equipment and operations (5.6%), recreation (4.8%) and new vehicles (6.1%), the bureau said.
“There are many categories that continue to post outsized month-over-month gains,” said Greg McBride, Bankrate’s chief financial analyst. “And [some of] these are categories that are firmly anchored in the household budget.”
“We need to see improvements in terms of mitigating pricing pressures across a variety of categories,” he added.
The overall energy index has fallen by 6.4% over the past year.
Average US gasoline prices topped $5 a gallon in June 2022 after oil prices surged after Russia invaded Ukraine in February 2022. The price increase for both regular motor gasoline and diesel fuel from February to March 2022 was the largest monthly gain on record, according to the US Department of Transportation.
It’s improving and the economy is cooling off, but it’s far from lukewarm.
Diane Swunk
Chief Economist at KPMG
For comparison, average pump prices in March were about $3.54 a gallon, according to the US Energy Information Administration. They have risen in recent weeks after a bloc of major oil-producing nations announced production cuts.
Housing accounts for the largest share of average household expenditure. Elevated home inflation has therefore served to support CPI readings.
There has been a “major” moderation in newly signed leases, said Paul Ashworth, chief economist for North America at Capital Economics. But price changes generally take nine months to a year to feed into CPI reports as economists calculate price changes in the housing category, he said.
“The big uncertainty is: We know housing costs should come down… soon [in the CPI]but none of us know exactly when,” Ashworth said.
The food-at-home index (meaning food prices) fell 0.3% in March, the first monthly decline since September 2020. That’s due to a combination of factors including lower prices for diesel, a key component of getting food around the shops, and an easing of the supply chain problems, said Zandi.
“It signals that the food inflation fever has been broken,” Zandi said.
Why inflation has emerged and remains high
Consumer prices started to rise rapidly in early 2021 as the US economy started to reopen after the pandemic shutdown. Americans unleashed a tide of pent-up demand for restaurants, entertainment and vacations, aided by savings amassed from government relief.
Meanwhile, the rapid economic restart disrupted global supply chains, a dynamic exacerbated by Russia’s invasion of Ukraine. In other words, the supply has not kept pace with consumers’ willingness to buy.
Inflation was first contained in categories of physical goods such as used cars and trucks. But the dynamic has changed.
“The supply shortage was a 2021, 2022 story,” Ashworth said.
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Now, inflation is more of a tale of “services,” which include categories like haircuts, auto insurance, airfare, medical care and rent, economists said.
That’s largely due to labor market conditions, which are characterized by historic labor demand, low unemployment and strong wage growth, economists said. Higher labor costs are forcing companies to raise prices, especially in labor-intensive service industries, economists said. While the labor market remains hot, it has gradually cooled.
The US Federal Reserve has aggressively raised interest rates to tame inflation. This mechanism aims to increase the cost of borrowing for consumers and businesses, which cut spending, thereby cooling the economy and jobs and ultimately inflation.
The recent turmoil in the banking sector is expected to reduce banks’ willingness to lend – and these tighter credit conditions are likely to further cool the economy and help tame inflation.
That credit crunch will likely help cool inflation in the second half of the year, Swonk said.
“It’s a slow push,” she said.