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This morning’s final pre-Ukraine War Labor Department report on U.S. inflation (for February) contained some relief for data geeks: The “baseline effect” for headline inflation that I (and others) have been arguing has kept reported price rises higher than they’d ordinarily be, seems to have come to an end. 

So going forward, these data should stop confusing the inflation picture (which would already have been worrisome enough). That’s because on an annual basis, they’ve partly stemmed from the inflation figures from 2019-2020 and early 2020-21 being uusually low because of the CCP Virus, related lockdowns, and their depressing effect on economic activity and consumer prices.

Not that the nature of inflation will become entirely clear – or that the news on the prices front is becoming remotely good. After all, regardless of how strongly or not the U.S. economy keeps recovering from its pandemic-related ills, headline inflation appears bound to get worse going forward because of the disruptions to global oil and food supplies resulting from the Ukraine conflict – including curbs on purchases of energy from Russia. And these of course are coming on top of the supply chain snags that have pushed inflation up because of the peculiar stop-start nature of the pandemic era economy and its only gradually normalizing aftermath.

The February numbers indicate that the baseline effects are already shrinking for core inflation data, too. These strip out both energy and food costs because they’re seen as unusually volatile for reasons having nothing to do with the economy’s underlying inflation “prone-ness.”

Not that this distinction between headline and core inflation is or ever has been truly clearcut. Energy prices, in particular, strongly affect the costs of virtually everything created or provided by businesses (including food!). So the energy and food components of headline inflation clearly bleed into core inflation.

Even so, deciding the nature of inflation’s main causes matters because they heavily influence the response of the Federal Reserve – which is required by law to help maintain price stability (along with promoting employment). If the Fed judges that today’s inflation is mainly the classic type – consumer demand growing much faster than the supply of goods and services simply because Americans have too much spending power – then it will continue responding, as it has so far. That is, it will keep reducing the massive stimulus it injected into the economy during the sharp virus-induced recession.

Such monetary “tightening” would slow growth (and cool off prices), and even risk another recession. But so far, the Fed seems convinced that’s a risk worth taking in order to bring inflation under control.

But if the central bank changes its mind and assigns much more blame for inflation to serious price shocks in energy and commodities due to the Ukraine conflict, then it will probably keep monetary policy extremely loose, or tighten less and even more gradually than originally planned.

Adequate growth, therefore, could be maintained, but prices could spiral to genuinely dangerous degrees, and inflation’s momentum could strengthen further because both producers and consumers will start behaving as if they expect prices to keep surging.

That headline figure for the Labor Department’s inflation gauge (called the Consumer Price Index, or CPI) – the gauge that includes food and energy prices – saw its biggest relative monthly jump (23.08 percent, from 0.65 percent to 0.80 percent) since October (when it more than doubled). Further, its level in absolute terms was the highest since October’s 0.87 percent.

Core inflation, however, actually slowed down in February – from January’s 0.58 percent increase to 0.51 percent. And the deceleration (12.07 percent) was the biggest since November’s (13.33 percent).

As for the baseline effect, a February fade becomes clear upon examining the latest monthly annual changes in headline inflation with those that came the year before. Let’s start with the March through December, 2021 period, with the 2020-21 monthy figure on the right and the 2019-20 figure on the far right . (March is chosen because that’s the month in 2020 when the virus’ first major economic effects were felt.)

March:    2.66 percent     1.53 percent

April:     4.15 percent      0.36 percent

May:      4.94 percent      0.24 percent

June:      5.34 percent      0.73 percent

July:       5.28 percent      1.03 percent

Aug:      5.21 percent      1.33 percent

Sept:      5.39 percent      1.40 percent

Oct:       6.24 percent      1.18 percent

Nov:      6.83 percent      1.14 percent

Dec:      7.10 percent      1.28 percent

Given that the Fed’s recent annual inflation target has been two percent, you can see how weakly headline prices rose in 2019-20, and why the economy’s return to normal the following year created a catch up effect for prices.

The two monthly figures below show the annual 2021-22 changes in the monthly inflation rates for the first two months of the year (on the right) and for 2020-21 (on the far right).

Jan:       7.53 percent      1.36 percent

Feb:      7.88 percent      1.68 percent

To me, the end of the baseline effect is augured by the newest, February numbers because the 2020-21 headine inflation rate made its closest approach to the two percent target in more than a year, and at the same time, a strong speed up took place in the 2021-22 annual headline rate. And in March, 2021, the annual headline inflation rate blew past the target – reaching 2.66 percent. So the next CPI report (covering March) should make clear that the baseline effect is completely gone.

By contrast, the annual core inflation figures still look pretty baseline-y. In fact, they’re looking increasingly baseline-y. Here’s how the recent annual results by month compare with those for the year before for March through December, 2021. Again, the 2020-21 results are on the right, and their 2019-20 counterparts on the far right:

March:    1.66 percent     2.12 percent

April:      2.97 percent      1.42 percent

May:       3.81 percent      1.25 percent

June:       4.45 percent      1.20 percent

July:        4.20 percent      1.54 percent

Aug:        3.96 percent      1.71 percent

Sept:        4.04 percent      1.72 percent

Oct:         4.59 percent      1.63 percent

Nov:        4.95 percent      1.64 percent

Dec:         5.48 percent      1.60 percent

The pattern here is somewhat different from that of headline inflation, in that the 2019-20 figures generally stayed and moved closer to the Fed’s two percent target through September. But then, they began a retreat, even as 2021-22 rates quickened. And the baseline effect became much more conspicuous in January and February, as the 2020-21 annual rates slowed dramatically while the 2021-22 rates increased markedly.

Jan:           6.04 percent     1.39 percent

Feb:          6.42 percent     1.29 percent

As shown above, annual core inflation bounced back to 1.66 percent in March, 2021. That’s still below the Fed target, but if next month’s CPI report shows a continued speed-up in the annual rate, that would be pretty strong evidence that this baseline effect is gone, too.

Unfortunately, unprecedented baseline-induced inflation confusion seems sure to turn into major energy and other commodity shock inflation confusion – making the Fed’s judgements about why prices keep rising so strongly more important than ever.