25 July 2018
Bob Cunneen, Senior Economist and Portfolio Specialist
US inflation vs interest rates
Sources: Federal Reserve Bank of St Louis and Federal Open Market Committee (FOMC) meeting minutes for June 2018.
US’s price pressures continue to build. The Core CPI Index measure (which excludes volatile food and energy prices) shows US inflation was running at a 2.3% annual pace in June (blue line). This places core US inflation above the central bank’s 2% inflation target as well as their current policy interest rate range between 1.75% to 2% (red line). Indeed the US Federal Reserve (Fed) has noted recently that “many business contacts indicated that they were experiencing rising input costs, and, in some cases, firms appeared to be passing these cost increases through to consumer prices”.
President Trump’s current strategy of imposing tariffs on imported goods provides further upside risk to US inflation. The recent tariffs on steel, aluminium and select imports of electronics and machinery from China have yet to be fully passed on to US consumers. The threat of US tariffs on European car imports would also have a significant impact on US consumer prices should these materialise. As a rule of thumb, a broad 10% tariff would raise US consumer prices by a further 0.2% based on historical measures.*
For the Fed, this tariff strategy only adds pressure to further raise US interest rates. While the Fed’s guidance is that future interest rate rises should be “gradual”, the reality is that these ‘Trump tariffs’ could force the Fed to accelerate the pace of interest rate rises to keep US inflation in check.
*Estimates for the 10% tariff impact on US inflation are based on our calculations of the “Yellen inflation model” which shows a coefficient of 0.26 for imported good prices from China, Europe and Japan.
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