Is the inflationary bubble bursting? A lot is hinging on the answer.
Fed Chairman Jay Powell has indicated inflation is transitory and so monetary policy support is still needed. By contrast Senator Joe Manchin has cited inflationary worries for limiting his support for the Biden administration’s infrastructure plans.
Recent data shows inflation is slowing from high levels. The U.S. Consumer Price Index increased by 5.3% in August, slightly down from 5.4% in July. At the same time, U.S. international import price inflation slowed to 9.0% in August from 10.3% in July, marking the slowest rate of growth since March.
The two data points have raised hopes that the current bout of inflation may be over.
Not so fast. The drivers of recent inflation are deeply rooted in supply chains and are playing out over quarters, not months.
First, price inflation is a global issue and not just one driven by U.S. consumer demand. The U.K. consumer price index increased by 3.0% year over year in August, up from 2.1% in July. Additionally, China’s producer price index also increased to 9.5% in August from 9.0% in July, marking a 13 year high.
Second, cost inflation is not a new phenomenon and has had many contributing factors. US import prices had increased in 14 of the past 15 months before August. A drop in oil and fuel prices was the major driver of lower import prices and have since increased in September. At the product line, import prices for plastics, base metals and semiconducting devices all continued to expand.
Third, the transmission of higher input prices to customer prices can take an extended period of as much as six- to nine-months even in commodity sectors such as coffee. Inflation can also become more permanent if manufacturers and retailers believe they have effective pricing power, as several automakers have already indicated. Similarly, consumer’s inflationary expectations can become more fixed the longer inflation stays elevated.
Fourth, the fundamental demand- and supply-side drivers of higher prices may not disappear quickly. Examples include:
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Finally, exogenous factors such as extreme weather and geopolitical risks have added additional stresses. Hurricane Ida has caused disruptions and price rises for building materials plastics and oil while the coup in Guinea which has been linked to record aluminum prices.
So, supply chain inflation is not new and may not go away until well into 2022, feeding consumer price rises for months after that. The persistence of cost inflation requires a continual review by supply chain decision makers of their budgets, their mix of short- and long-term purchasing policies and their customer pricing strategies.
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