The Consumer Price Index for July was unchanged from the month before and fell to +8.5% on a year-over-year basis, providing the first good news on the inflation front for some time. It’s worth noting, however, that while an 8.5% annual increase represents some relief from preceding months, this level is still above where we were in April of this year. Excluding 2022, you have to go back to the early 80’s to find higher inflation figures.
So while there are some positive markers surrounding inflation, we are nowhere near out of the woods yet. To some extent, an easing of inflation was expected. As we move forward each month, current prices are already drawing comparisons to the inflated prices of a year ago, making it harder to maintain elevated levels of year-over-year inflation. The fact that gas prices have started to drop gives consumers comfort. Key drivers of recent inflation — gas and auto prices — have seen some recent softness and consumer sentiment ticked up in July off of record lows.
However, it’s not all a positive story. Services inflation hit 6.3% on a year-over-year basis in July. Services account for over 60% of the weight in the CPI number, so it remains a concern moving forward. As Americans return to a “new normal” post-pandemic, spending on services such as transportation and recreation has increased. Shelter expenses, in particular rent, remain a major issue. Rent prices continue to spiral and once those prices are baked in, it’s hard to see them retreating.
Of course, services price inflation was expected as the pandemic effects began to wear off. The increase in services prices was supposed to be offset by a concurrent reduction in spending on goods, however. If the July retail sales numbers are any indication, this is certainly not happening. Retail sales in July, excluding auto and gas sales, were up 0.8% month-over-month and 7.1% year-over-year.
Total retail sales are up 7.3% this year versus 2021. Given that retail sales over the course of 2020-2021 increased by more than 20% over 2019, the fact that we’re still seeing strong growth in 2022 is a testament to the strong financial position that consumers are in despite the challenges with elevated inflation. Some of the growth we’re seeing is being driven by price inflation but even if we back out inflation, retail sales remain robust on a real basis.
Even if gas and auto prices continue to weaken in coming months, it’s hard to see how inflation drops down to the levels that the Fed is currently targeting. We may continue to see some weakening of the headline inflation number over coming months, but any dramatic easing is hard to imagine. Real average hourly earnings for all employees actually increased from June to July by 0.5%. While this reverses a trend of negative real wage growth, consumers retain large cash balances built up over the pandemic, and when those are coupled with rising wages, we have a situation where spending can remain elevated in the face of inflation.
It's worth noting that this isn’t just an American problem. Inflation has been rising in many countries. Eurozone inflation now exceeds U.S. CPI, with July numbers coming in at 8.9%. UK inflation surpassed 10% in July, hitting 40-year highs. Given that we compete in a global market for commodities and finished goods, supply challenges are also an important factor in driving inflation. July’s Producer Price Index numbers, although down from June, are still up almost 10% on a year-over-year basis. This index tracks wholesale prices — the prices that retailers pay for the goods they make available to consumers. As long as demand remains robust and supply remains challenged, it’s difficult to see how inflation drops dramatically anytime soon.
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