It is a genuine relief to many – including me – that Wednesday's U.S. inflation numbers came in lower than consensus forecasts had predicted, both for the headline and core measures. This is good news for Americans facing crippling bills, eroding purchasing power and mounting economic insecurity. It is also good news for markets, illustrating the extent to which the economy and finance are aligned on the importance of controlling a multi-dimensional menace that has been eroding the prospects for inclusive and sustainable growth.
That's the good news, and it is welcomed progress after a year-plus of almost nonstop disappointments. Yet, with inflation still too high, it is progress that needs to be maintained and built-upon in the months and quarters ahead, especially given what else the the economy as a whole is telling us.
First, a quick review of the key inflation data just released:
- Headline inflation fell from 9.1 percent in June to 8.5 percent in July, below the consensus forecast of 8.7 percent.
- The core inflation measure, which by convention excludes energy and food prices as they are deemed overly volatile (up-and-down), was unchanged at 5.9 percent, below the consensus forecast of 6.1 percent.
- On a monthly basis, headline inflation was flat as the sharp fall in energy prices (4.6 percent), led by gasoline (7.7 percent) offset not just higher food prices (up 1.1 percent) but also broad-based price increases elsewhere as illustrated by the 0.3 percent monthly rise in the core measure.
The moderation in headline inflation is certainly good news and reflects the work the Biden administration has been doing on the energy front in particular. It will help ease what has been rapidly compounding pressures on the budgets and livelihoods of Americans, particularly the most vulnerable segments of our society. It also lowers the still-concerning probability of the economy slipping into a recession over the next few months.
No wonder financial markets had such a favorable reaction to the new inflation numbers. Stocks surged higher and bond yields fell, good news both for companies, for mortgages, and for the fortunate households with financial wealth. As important, the traditional market measure of recession risk – that is, "curve inversion," or the extent to which the yield on 10-year bonds trades below that on 2-year – flashed somewhat less of a loud warning signal.
Having said all this, it is important that we don't get carried away in our relief, as genuinely welcome as it is.
At 8.5 percent, prices continue to go up at still a worrisomely high pace, eroding even more purchasing power and adding to household economic insecurity. Moreover, because the Federal Reserve has been so late in recognizing the inflation problem for what it is and in responding with credible policy measures, the drivers of this inflation are now broad-based.
We are not yet out of the woods. Far from it.
While headline inflation moderated in July, and did so more than widely anticipated, it remains a big problem. Allowed to fester for too long, by the Fed in particular, it is now an entrenched multi-dimensional challenge that has economic, social, financial, institutional and political influences.
It is crucial, not just for our economy but also for the global one, that our Fed – the most powerful central bank in the world – maintains its policy response and recovers its damaged credibility. Failing that, our collective desire to put the inflation genie back into the bottle, and the efforts of the Biden administration and Congress to do so, will prove to be of only limited effectiveness.
Mohamed A. El-Erian is president of Queens' College, Cambridge University. He is an advisor to Allianz and Gramercy Fund Management, the Rene Kern Professor of Practice at The Wharton School, and a senior fellow at the Lauder Institute of the University of Pennsylvania.