Economic Outlook: Understanding Inflation and Interest Rates
The current economic situation is complex, with various factors influencing inflation and interest rates. Recently, the ISM price components indicated that tariffs might still pose a lingering inflation threat. However, the NFIB survey revealed that small businesses are finding it challenging to pass on these costs to customers, as the number of firms expecting to raise prices in the coming months decreased from 32% to 28%.
Inflation Pressures: Then and Now
To grasp the current inflation scenario, it’s essential to compare it with the situation in 2021/22. During that period, inflation soared to 9%, driven by tripled oil prices, surging house prices, and housing rents. The jobs market was also extremely competitive, with high employee turnover and soaring wages, which further amplified the post-Covid supply-shock-related increase in goods prices. In contrast, the present situation is characterized by disinflationary influences, including cooling housing rents, which are expected to offset the impact of tariffs in the coming quarters.
The Impact of Tariffs on Prices
While many prices may eventually rise due to tariffs, it’s unlikely that inflation pressures will persist. The difference between the current situation and the previous one is significant. The combination of factors that led to high inflation in 2021/22 is no longer present, and the economy is now experiencing a slowdown. As a result, the effect of tariffs on prices will be mitigated by the overall disinflationary environment.
The Jobs Market and GDP Growth
The jobs market, which was previously solid, is now showing signs of weakness. Additionally, consensus GDP growth forecasts have been revised downward from 2.5% to 1.5% since the beginning of the year. These developments suggest that the economy is slowing down, which will likely influence the Federal Reserve’s decision on interest rates.
The Fed’s Likely Response
Given the current economic situation, it’s probable that the Fed will cut the policy rate in September. This move is expected to be followed by additional 25bp cuts in October and December. The Fed’s actions will be aimed at stimulating the economy and mitigating the effects of the slowdown.
Conclusion
In conclusion, the current economic outlook is characterized by a complex interplay of factors influencing inflation and interest rates. While tariffs may still pose an inflation threat, the overall disinflationary environment and the slowdown in the jobs market and GDP growth are likely to mitigate their impact. The Fed’s expected response, including cutting the policy rate, will aim to stimulate the economy and address the current challenges. As the economic situation continues to evolve, it’s essential to monitor the developments and adjust expectations accordingly.
