Stubborn Inflation Means Higher Interest Rates for Longer

If you’ve filled up your car’s gas tank, gone out to eat, or had your insurance premiums raised lately, you’ve no doubt noticed that high inflation is once again rearing its ugly head. Now, that inflation may also hurt your finances when it comes time to take out a loan.

Inflation has run hotter than experts had forecast during the first three months of the year, a trend that was only solidified by Wednesday’s report on the Consumer Price Index (CPI) for March, which showed that the cost of living rose 3.5% over the last 12 months, well above the Federal Reserve’s target of a 2% annual rate. 

The third overheated inflation report in a row could force the Federal Reserve to keep its benchmark interest rate higher for longer, pushing up borrowing costs on mortgages, credit cards, and all kinds of other loans. The Fed has kept its benchmark fed funds rate at a 23-year high since July in an attempt to force down inflation and cool off the economy. 

With inflation having fallen considerably since its recent peak of a 9.1% annual rate last June, Fed officials have said they expect to cut interest rates at some point this year. But inflation and the economy have both run hotter than expected, throwing those plans into doubt and putting upward pressure on borrowing costs.

Fed officials have said their decision on when to lower interest rates will be guided by data, and unexpectedly high inflation  is unlikely to instill confidence that they can lower interest rates without inflation flaring up again. 

Fed officials have been attempting to take upward pressure off prices by making it costlier for individuals and businesses to borrow money, and hence spend it. High interest rates can subdue inflation but risk causing a recession and mass layoffs—a scenario that Fed officials hope to avoid.

However, with inflation bouncing back, employers still in hiring mode, businesses still booming, and consumers still spending like there's no tomorrow according to recent economic reports, Fed officials have more reasons to delay rate cuts.  

“Given this situation a June rate cut is not happening, barring a rapid reversal of fortunes for the economy,” James Knightley, chief international economist at ING, wrote in a commentary. “July is also doubtful, meaning September is the more probable start point of any easing, which would limit the Fed to a maximum of just three rate cuts this year.”

To be sure, there is still reason to think that inflation will cool off in the coming months. The biggest driver of the official inflation measure is rent, and according to unofficial estimates from private companies, rent inflation has slowed dramatically over the last year. 

Changes in rent tend to show up in the CPI many months later due to how the Bureau of Labor Statistics carries out the surveys it uses to compile the official inflation measure, so those changes are bound to put downward pressure on inflation at some point. 

However, the more months in a row that inflation data is worse than expected, the less likely it is that high inflation is just a statistical fluke that can be overlooked. 

“The buoyant advance in inflation in March pours cold water on the view that the faster readings in January and February simply represented start-of-the-new-year price increases that were not likely to persist,” writes Nationwide Chief Economist Kathy Bostjancic. “The lack of moderation in inflation will undermine Fed officials’ confidence that inflation is on a sustainable course back to 2% and likely delays rate cuts to September at the earliest and could push off rate reductions to next year."