Inflation appears to be cooling, but is it really?

While the Consumer Price Index shows price growth slowing, a two-year comparison offers a reminder that inflation is still high.

Inflation appears to be cooling, but is it really?

For months, the view of inflation across the US economy was relatively clear, as prices rose at a rate last seen in 40 years. However, the data from October isn’t offering a uniform view.

There were signs in the Consumer Price Index that inflation may be starting to cool. But zoom out, and it looks like more of the same altitude. Meanwhile, the Adobe Digital Price Index showed prices decreasing on an annual basis, while rising on a monthly basis. It’s all coming as early holiday discounts and campaigns for retail’s peak season are starting to show up.

Let’s dig in:

Consumer Price Index: Inflation at 7.7%

The Consumer Price Index showed that prices across the economy rose 7.7% on an annual basis in October. It jumped 0.4% over September, which was below economists’ expectation of 0.6%. The three indices reflecting primary needs were as follows:

  • Energy increased 1.8% for the month, heading back upward after three straight months of decreasing. Notably, the price of gasoline was up 4% monthly.
  • Food rose 0.6%, down from a 0.8% increase in October. The food at home index, which includes groceries, was up 0.4%. That was that category’s smallest increase since December 2021. However, the inflation oven is still hot in this category, as prices rose 12.4% year-over-year.
  • Shelter contributed over half of the increase to prices in October. Prices in this category, which includes rent, rose 0.8% on a monthly basis. That was the highest increase in this category since 1990.

Core inflation, which leaves aside the more volatile food and energy prices, rose 6.3% annually. The monthly increase was 0.3%, which was below economists’ expectations of 0.5%. That was down from 0.6% increases in both September and August, signaling slowing prices.

Overall, goods prices fell 0.4%, with Bank of America Research noting that the slowdown in this category is also “showing signs of broadening.” Price changes in key consumer goods categories included:

  • Apparel prices fell 0.7%, and rose 4.1% annually.
  • Personal care items rose 0.5%, and were up 6.4% on the year.
  • Household furnishings prices fell 0.2% month-over-month, while rising 8.4 percent annually.

Does this mean inflation is cooling?

After months of 40-year-high inflation and rate hikes by the Federal Reserve to combat it, the monthly numbers began to show signs that price increases are slowing.

In recent months, we’ve become accustomed to year-over-year headline readings above 8%, even topping 9% in June. So, seeing growth recede into the 7% range will likely be welcomed in many circles. It also appears that trends are moving in the right direction. The 7.7% annual increase was the lowest since January 2022, which is the first time we’ve written about a marked decline in a year that has broken records. Each of the annual increases in food, energy and shelter were also smaller than in September, and the monthly core inflation increases were down.

However, inflation is still elevated overall, and people will feel it. High food and rent prices stand to continue to put a strain on discretionary income heading into the holiday season. Consumer goods companies have also said on earnings calls that they are planning to continue to increase prices as costs rise.

Inflation has been high for many months now. In fact, we are beginning to lap the period when prices began to seriously heat up on a yearly basis. That changes year-over-year comparisons. An 8% increase over a month when prices rose 2% looks very different from a comparison of months that both saw 8% increases. The baseline changes. So it can become helpful to take a wider view. And when considering the entire scope of this period of elevated inflation, it becomes even more evident that prices are still unusually high.

Inflation began to tick up steadily in April 2021, as the second round of stimulus checks began to arrive, throwing even more demand for goods at a strained supply chain. A 6.2% increase in October marked a step change in price growth that began the CPI’s upward march to levels not seen since the 1980s that we have today. So the year-over-year comparison is not to a month when inflation was 2%, but rather to one when it was already high. Given this, a useful view could be to look at the rise in prices over a two-year period. On that reading, inflation is still up 14.4%, far above what it was in January 2021. In fact, inflation on this reading is at the highest level since its peak in June, when the two-year increase was 14.9%.

chart showing inflation over 2 years

2-year inflation rate. (Source: CPI, Image: The Current)

This all makes deciding what to do next – not to mention, how to message its moves – an even trickier job for the Fed, which has no shortage of conundrums these days. On one hand, there may be a desire to point to this month’s report as evidence that rate hikes are working. After all, the Fed wants its tools to work, and benefits from being able to show that. Interest rate hikes cool the economy, so trumpeting the fact that inflation as intended offers a sign that the “pain” is worth it. When it comes to the battle against inflation itself, there is also a psychological advantage in being able to demonstrate that prices are coming down. Policymakers want people to see evidence of lower inflation. In turn they may spend on discretionary purchases at a more regular pace, and back off of asks for higher wages that could trap the economy in an upward cycle of price increases.

However, one report does not mean the Fed can declare victory yet. That’s especially true when the CPI remains far above the 2% that it is ultimately targeting, and even moreso when the year-over-year comparisons get more complicated. Further, Fed Chairman Jerome Powell has said over and over that the Fed will not stop its work until “the job is done,” and that rate increases aren’t stopping anytime soon.

One path here may be to reduce the size of rate increases. This approach already appears to be at least in the pipeline. Powell offered a hint that it may do so after last week’s Fed meeting, saying that there would be a “discussion” about whether a lower increase would be prudent in December. In a research note, Bank of America said that Thursday’s CPI led its analysts to stick with a prediction of a .5% increase next month, which would be below the 0.75% hike of the last four straight meetings.

But it’s not a sure thing. There is a lot of data to consider, and it is starting to show mixed messages. Last week’s Labor Department report for October showed new jobs are still being created, but unemployment is ticking up. This week, the CPI showed that inflation is cooling, but still remains historically high. Layer on that during this period, things that are usually good for the economy (job growth, spending) are actually bad in the Fed’s view because they mean interest rate hikes aren’t working to cool inflation. Powell got great reviews for his performance at last week’s press conference, but the nuance is only piling up and the forecasts calling for a recession in 2023 are only continuing. It will be just as interesting to hear what Powell says about the current state of the economy as it will be to see what the size of the rate increase is.

Philadelphia Fed President Patrick Harker offered one approach to the message in a speech on Thursday: "In the upcoming months, in light of the cumulative tightening we have achieved, I expect we will slow the pace of our rate hikes as we approach a sufficiently restrictive stance. But I want to be clear: A rate hike of 50 basis points would still be significant," he said.

He added, "And we also need to recognize that this will take time: Inflation is known to shoot up like a rocket and then come down like a feather."

Or, as San Francisco Fed President Mary Daly put it Thursday during a Q&A with the European Economics and Financial Centre, “One month of data does not a victory make."

Adobe DPI: Annual deflation continues

Year-over-year digital inflation, 2015-present. (Courtesy: Adobe)

The mixed signals continued when considering the prices paid for goods bought through digital channels.

In October, ecommerce prices fell 0.7% year-over-year on an annual basis, while rising 0.3% month-over-month, according to the monthly Digital Price Index from Adobe Analytics. The year-over-year decrease proved to accelerate the fall that began in September, when prices fell 0.2%.

This was driven by falling prices for electronics and toys, as early holiday discounts kicked in. However, 10 of the 18 categories tracked by the DPI had year-over-year increases, led once again by food. Let’s take a look at key categories:

Electronics, which has the highest share of ecommerce spend by category, were down 12.9% year-over-year, which was a record decline for the category. Prices fell 2.4% month-over-month. Computers, meanwhile, saw a 16.4% year-over-year decrease, which was the largest fall since the onset of the pandemic in 2020.

Toys fell 7.1% year-over-year, and 3.5% month-over-month. With discounts starting for the holidays as a result of early deals events, the year-over-year increase was up markedly from the prior months.

Sporting goods posted a record decline, as well, with a 4% year-over-year decrease. Even so, prices were up 0.3% month-over-month.

Groceries, however, continue to see rising prices. Mirroring the CPI’s food index, prices in this category rose 14% year-over-year, but did begin to slow from the 14.3% increase in September. Grocery prices have risen for 33 straight months. Other significant annual increases were observed in pet products (11.85%), medical equipment (6.5%) and apparel (5.1%).

Prices by category, Oct. 22 (Courtesy: Adobe)

Holiday start drives spending up in October

Heading into the holiday season, one question looms over many of the forecasts: How will higher prices affect demand?

So far, the answer for ecommerce appeared to be that spending was at least holding up.

Additional data released Thursday from Adobe Analytics showed that consumers spent $72.2 billion through ecommerce channels in October. That was a 10.9% increase from the month before. It appears that price had a big role: Consumers are spending more in categories like electronics, toys and computers, where discounts drove prices down.

“Despite inflationary pressures and the rising cost of borrowing, there was not a material decline this year in early holiday shopping,” said Taylor Schreiner, senior director of Adobe Digital Insights, in a statement. “With over $72 billion spent online in October, ecommerce demand has shown itself to be durable and resilient, in spite of a challenging macroeconomic environment.”

But it is not showing any growth, either. The total for October was roughly even with what consumers spent in October 2021, when sales were $72.4 billion. Both years featured early deals that led to an uptick in spending. Adobe had forecast that online ecommerce sales would increase only 2.5% for the holiday season in 2022, down from 8.6% in 2021. However, forecasts have varied. The National Retail Federation predicted that nonstore and online sales will increase 10-12% for the holidays.

For the year, consumers spent $727 billion through October, according to Adobe. That's up 6.9% compared to January-October of 2021.

More insights from Adobe offer a window into the stickiness levels of online shopping trends that rose in the pandemic:

Online grocery sales rose 27.9% year-over-year for the month, and that total is expected to increase as Thanksgiving approaches.

Buy Now Pay Later revenue share was up just 1% year-over-year, continuing a trend of slower growth for the preceding months of the year, when revenue share was up 5%. “While the growth has been partly affected by the broader economic environment and a slowdown in consumer spending, BNPL is also contending with challenges in demonstrating value to mass consumers,” Adobe states.

Curbside pickup accounted for 17% of orders in October, which was down from the 24% that this practice had in October 2021, when the pandemic was still prompting safety precautions. However, this option could rise in December for another reason: Consumers want to avoid shipping delays.

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