Fed Chair Jerome Powell keeps saying that inflation is temporary.
"We are not convinced. Given the breadth of the upward pressure on both prices and wages, we believe there is a danger that this will develop into a sustained wage-price spiral," writes Paul Ashworth, Capital's chief U.S. economist in a recent note. "We expect core inflation to consistently exceed the Fed’s target over the next few years but, with the Fed more focused on achieving its inclusive full employment goal, we still don’t expect the Fed to begin hiking interest rates until 2023."
As the nation begins to contain the COVID-19 pandemic by vaccinating millions of American adults and further eases pandemic restrictions, core inflation could see a boost, as the prices of services that were hard hit begin to recover, according to Ashworth. More than a third of the U.S. is fully vaccinated, according to the latest numbers from the Centers for Disease Control and Prevention. More than 45% of Americans are at least partially vaccinated.
"The big question is whether they simply return to pre-pandemic levels or, because of strong pent-up demand, they blow past those levels to new highs? After falling by 20% last year, car rental prices are now 25% above pre-pandemic levels. Air fares and hotel room rates are still significantly lower, but the high frequency data show a very rapid recovery over the past month or two in both activity and prices," he writes.
Ashworth expects headline and core inflation to rise over the next several months -- but with some caveats. Headline inflation, for example, will be most affected because of the extent of the "short-lived drop" in energy prices and the later rapid rebound -- but should come back down.
"The more pressing inflationary problem is the now widespread shortages in not just semiconductors but most raw materials and intermediate inputs. The resulting surge in commodity prices, shipping costs and survey-based measures of prices paid by firms, point to significant upward pressure on inflation for at least the next few months," he writes. "These so-called bottlenecks are often characterised as temporary supply disruptions but, with exports from many Asian countries, including semiconductors, above pre-pandemic levels and U.S. imports also elevated, this looks more like global supply simply unable to keep up with red-hot demand, which has been turbo-charged by an unprecedented degree of policy stimulus. Under those circumstances, these shortages, and the resulting strong upward pressure in prices, could easily last until well into next year."
In sum, Ashworth sees headline consumer price index inflation peaking at close to 4% shortly, and to average 3% in 2021. A subsequent decline in energy prices will then allow headline inflation fall to around 2.0% in 2022 and 2023.
"But we expect core CPI inflation to remain elevated at 2.5% for the next couple of years. Furthermore, while it would normally be 0.3% points or so lower, we also expect the Fed’s preferred core personal consumption expenditures inflation measure to average 2.5% in 2021 and 2022."