The recent surge in U.S. prices, which marked the biggest increase in 40 years, has finally come to an end. However, the battle against inflation is far from over.
Consumer inflation saw a modest rise of only 0.2% in July, marking the third consecutive month of mild readings. Over the past year, consumer prices have climbed by 3.2%, a significant decrease from the peak of 9.1% last year.
The Federal Reserve’s Perspective
Another measure of inflation, which is favored by the Federal Reserve, also remained relatively low last month.
However, it is important to note that the rate of inflation still surpasses the Fed’s target of 2%. Prior to the pandemic, inflation increased by less than 2% annually.
The Crucial Role of Labor Costs
For the Federal Reserve to effectively combat inflation, it is imperative for labor costs to decrease. This includes not only wages and salaries but also benefits.
So far, the evidence regarding labor costs is mixed.
While labor costs are rising at a slower pace, they still exceed the trend as workers understandably seek higher compensation due to the increased cost of living.
In recent months, employees at companies such as UPS have successfully negotiated substantial wage increases.
However, the increase in hourly pay has remained stuck at around 4.4% since early spring, which is considered too high for the comfort of the Federal Reserve.
Considering that labor expenses are the largest financial burden for most businesses, particularly in the service sector, it is crucial to address inflation in this area.
U.S. economist Thomas Simons at Jefferies warns that if inflation in labor-intensive sectors fails to slow down further, the Federal Reserve will face significant challenges in driving out the remaining above-target inflation.
He also notes that the recent resilience in average hourly earnings and the success of labor unions in securing considerable wage and benefit increases for their members increase the risk of a rebound in inflation.
The Target Ahead
Economists suggest that in order to achieve the 2% inflation target, the annual increase in labor costs should slow down to 3.5% or preferably even lower.
If this target is not met, the core rate of inflation could remain above 3% for an extended period.