US inflation and consumer spending cooled in December

The Federal Reserve’s preferred inflation gauge eased further in December, and consumer spending fell – the latest evidence that the Fed’s series of interest rate rises are slowing the economy.

Friday’s report from the US Department of Commerce showed that prices rose 5 percent last month from a year earlier, down from a 5.5 percent year-over-year increase in November. It was the third straight drop.

Consumer spending fell 0.2 percent from November to December and was revised lower to show a drop of 0.1 percent from October to November. Last year’s holiday sales were sluggish for many retailers, and the overall spending figures for the final two months of 2022 were the weakest in two years.

The pullback in consumer spending will likely be welcomed by Fed officials, who are seeking to cool the economy by making lending increasingly expensive. A slower pace of spending could boost their confidence that inflation is steadily easing. Still, the decline in year-over-year inflation matched the Fed’s outlook and is not likely to alter expectations that it will raise its key rate by a quarter-point next week.

On a monthly basis, inflation ticked up just 0.1 percent from November to December for a second straight month. Energy prices plunged 5.1 percent, and the overall cost of goods also fell.

“Core” prices, which exclude volatile food and energy costs, rose 0.3 percent from November to December and 4.4 percent from a year earlier. The year-over-year figure was down from 4.7 percent in November, though still well above the Fed’s 2 percent target.

Falling prices for oil, gas, copper, lumber, wheat and other commodities, along with the unclogging of supply chains, have helped slow the retail costs of cars, furniture and clothes, among other items.

Price increases, though, have remained persistently high for some goods and services, including eggs, which skyrocketed 60 percent last month compared with a year ago. Egg prices rose 11.1 percent just in December, inflated by an outbreak of avian flu that has led to a culling of herds and higher feed costs.

Car rental prices have also soared nearly 27 percent from a year ago and rose 1.6 percent just in December.

But for many other items, inflation is easing. Coffee prices, though up nearly 14 percent in the past year, rose just 0.2 percent last month. And the cost of clothes and shoes rose just 3 percent in the past year and 0.3 percent last month.

Friday’s figures are separate from the better-known inflation data that comes from the consumer price index. The CPI, which was released earlier this month, has also shown a steady deceleration.

“The latest data offer the first tangible signs that the economy’s main engine is slowing,” said Oren Klachkin, lead US economist at Oxford Economics, referring to consumers, whose spending accounts for about 70 percent of economic activity.

The Fed has been seeking to slow spending, growth and the surging prices that have bedevilled the nation for nearly two years. Its key rate, which affects many consumer and business loans, is now in a range of 4.25 percent to 4.5 percent, up from near zero last March. Though inflation has been decelerating, most economists said they think the Fed’s harsh medicine will tip the economy into a recession sometime this year.

“We continue to see the US economy experiencing a mild recession this year,” said Lydia Boussour, senior economist at EY Parthenon.

Low levels of unemployment

A recession typically causes widespread layoffs and higher unemployment. But for now, US employers are adding workers, and the unemployment rate remains at a half-century low of 3.5 percent.

Should job losses, which are occurring at many finance and tech companies, drive up unemployment, a recession could eventually be declared by a group of economists at the National Bureau of Economic Research, a nonprofit that officially determines when recessions occur. The economists at the NBER typically make such an announcement well after a recession has actually begun.

For now, the number of people seeking unemployment benefits – a proxy for layoffs – declined last week to 186,000, a very low level historically. And Walmart, the nation’s largest employer, said it would raise its minimum wage, from $12 to $14 an hour, to help it keep and attract workers.

The Fed is in an increasingly delicate position. Chairman Jerome Powell has emphasised that the central bank planned to keep boosting its key rate and to keep it elevated, potentially until the end of the year. Yet that policy may become untenable if a sharp recession takes hold.

On Thursday, the government reported that the economy grew at a healthy clip in the final three months of last year but with much of the expansion driven by one-time factors: Companies restocked their depleted inventories as supply chain snarls unravelled, and the nation’s trade deficit shrank.

By contrast, consumer spending in the October-December quarter as a whole weakened from the previous quarter, and business investment dropped off sharply. Overall, the economy expanded at a 2.9 percent annual rate in the October-December quarter, down slightly from a 3.2 percent pace in the previous quarter.

If consumers remain less willing to boost their spending, companies’ profit margins will shrink, and many may cut expenses. That trend could lead eventually to waves of layoffs. Economists at Bank of America have forecast that the economy will grow slightly in the first three months of this year – but then shrink in the following three quarters.

More frugal consumers would threaten to send the economy into a recession. But they can also help reduce inflation. Companies cannot keep raising prices if Americans will not pay the higher prices.

Last week, the Federal Reserve’s beige book, a gathering of anecdotal reports from businesses around the country, said, “Many retailers noted increased difficulty in passing through cost increases, suggesting greater price sensitivity on the part of consumers.”