Inflation is getting sneakier

For most of the last year, it’s been very easy to see what was driving high inflation. It was gasoline, and more broadly, energy. And everybody knew it, because of the giant signs that advertise gas prices in every town in the country.

Inflation is getting sneakier. Gas prices are down—way down—but overall inflation has barely budged. The annualized inflation rate fell just two-tenths of a percentage point in August, from 8.5% to 8.3%. Given plunging gas prices, economists expected a bigger decline. The magnitude of the drop matters, because it directly affects the Federal Reserve's decision-making on how much to raise interest rates, and how quickly.

Gasoline prices in August were up 26% from the year before, which is a hefty jump—but that’s down from a 44% jump in July and a 60% surge in June. (All of these figures are annualized, year-over-year numbers.) In other words, gas prices are still up year-over-year, but the pace is decelerating. If gas prices stay where they are—around $3.70 per gallon, on average—the annualized price change will actually turn negative early in 2023.

Two other important categories are going the other direction: food and household energy, as the following chart shows. Annualized inflation for groceries was 13.5% in August, up from 13.1% in July and 12.2% in June. That's the highest inflation rate for food since 1979. The cost of household energy—electricity, cooling and heating—was up 21.2% in August, compared with 20.5% in July and 21.9% in June.

Groceries account for 8.2% of the overall inflation measure. Household energy accounts for 3.5%. Gasoline accounts for 3.7%. So groceries and household energy combined account for 11.7% of the overall price index, or roughly three times as much as gasoline.

Does anybody know how much electricity costs on a monthly basis? Hardly. Utility bills are notoriously difficult to decipher and they’re priced in units such as kilowatt-hours and therms that are completely unintuitive. People notice when their monthly bill goes up or down, but not in real-time, as they do with gasoline.

Utility bills are going higher largely because of rising natural gas prices, which are more than double what they were a year ago. Gas prices affect electricity costs because many utilities generate power by burning natural gas. When power production costs go higher, utilities pass much of that on to consumers. So rising gas prices push household energy prices higher even in homes that aren’t connected to natural gas.

The Russian invasion of Ukraine is pushing US natural gas prices higher, even though the United States doesn’t rely on Russian gas, the way Europe does. Russian cutbacks on gas deliveries to Europe have forced Europe to look for other sources, including the United States. US natural gas exports, as a result, have surged to record levels. Natural-gas costs are way higher in Europe; they’re rising here, too, as demand for US energy skyrockets.

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It takes a lot of energy to produce and transport food, so higher energy costs typically push food costs higher. Other factors may be contributing to food-price inflation, such as ongoing supply-chain kinks. The cost of transporting food, meanwhile, ought to be declining, given the drop in gasoline and diesel prices. That’s one hint that food-price inflation might coming down during the next few months.

Markets booed the August inflation report, with stocks selling off. Higher-than-expected inflation means the Fed will almost certainly raise rates by three-quarters of a point at its Sept. 20 meeting. Higher interest rates make borrowing more expensive, which slows economic growth and dents corporate profits. Some investors were hoping that rapidly easing inflation would let the Fed slow the pace of rate hikes, which would generally be good for profits and stock prices. No luck. The Fed may have to keep hiking if inflation doesn’t moderate, which would darken the outlook for stocks.

But there are still some reassuring developments on inflation, as the chart above shows. New-car inflation is slowly easing, as the computer chip shortage gradually unwinds. The price of used cars—up 40% year-over-year at the start of the year—has dropped back to an annualized gain of less than 10%. The inflation rate for appliances, which also require microchips, was just 3% in August, down from 8.5% at the start of the year.

Natural gas may now be a more important indicator of the future path of inflation than gasoline. Prices have spiked recently in anticipation of a nightmare winter in Europe, with shortages causing blackouts, rationing and other dramatic problems. But Goldman Sachs now thinks European nations have taken measures to avert a full-blown crisis, and prices have dipped lately. US producers may drill more, to take advantage of higher prices, which in turn would bring prices down. Inflation hasn’t crushed us yet.

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