QNB expects US inflation to continue to moderate in the coming months towards acceptable levels, after it has declined significantly from its peak, supported by strong productivity growth, reduced labor market pressures, and slowing rent inflation.
The bank believes in its weekly report that this will pave the way for the beginning of the interest rate cuts cycle by the Federal Reserve next September, with two cuts of 25 basis points this year, and subsequent cuts of 25 basis points after every two monetary policy meetings until early 2026, when interest rates should stabilize between 3.75 and 4 percent.
Inflation in the United States is currently one of the most closely watched macroeconomic variables around the world, the report noted. Higher-than-expected price pressures over the past months have raised concerns that inflation could become more persistent and, if sustained, could undermine the Federal Reserve’s plan to begin easing monetary policy this year.
The Federal Reserve’s preferred measure of price action is the personal consumption expenditures price index, and the basic version of the index excludes the most volatile commodities, such as food and energy, which are affected by external factors, such as sudden weather changes and geopolitical events. By removing prices that are most vulnerable to short-term volatility, the index provides greater insight into underlying inflation trends.
According to the core PCE measure, inflation peaked in 2022 during the post-pandemic recovery, and since then, inflation has declined significantly, driven by the return of supply chains to normal, a healthy economic slowdown, and tighter monetary policy.
Although progress may be uneven, inflation will continue to approach the monetary policy target, allowing policymakers to begin the next round of rate cuts in September 2024, based on three main factors: First, strong productivity growth in the United States will help bring inflation back to the target. Increased productivity means that more goods and services can be produced with a given amount of resources, which reduces production costs and leads to lower prices for consumers. During the 1990s, advances in information technology and the Internet drove productivity growth, while increased efficiency and competition helped keep inflation under control.
In the three months to Q1 2024, nonfarm hourly output increased by an average of 2.7 percent year-on-year, well ahead of productivity growth in other advanced economies. Against the backdrop of strong productivity growth, unit labor costs have continued to decline markedly from their peak of 6.3 percent in Q2 2022 toward the pre-pandemic average of less than 2 percent in 2015-19, contributing to moderating inflation.
Second, slowing labor markets are expected to dampen workers’ demands for higher wages, reducing pressure on labor costs for businesses. With the unemployment rate at a record low of 4.1 percent, indicators that typically predict labor market conditions suggest that the market is losing momentum. The rate at which workers leave their jobs is also declining, a trend that suggests workers are becoming less confident in their ability to find new jobs or successfully seek better conditions in a new job. Likewise, the number of new jobs is continuing the downward trend that began in 2022. Given the importance of labor costs in the production of services and goods, a weak labor market will help contain price pressures.
Third, lower inflation in the housing component of the price index will be a major contributor to lower overall inflation in the coming quarters. Housing accounts for about 15 percent of the PCE index and includes either rent or, if the housing unit is owner-occupied, the cost of renting an equivalent unit in the current housing market.
Housing inflation peaked at 8.2 percent in April 2023, well after the peak of overall inflation, reflecting the stickiness or rigidity of prices in the sector, where costs are determined by long-term contracts and prices react more slowly to changes in macroeconomic conditions. Rents can only change when a lease expires, which usually happens annually. Housing inflation has been falling steadily since mid-2023 and is currently below 6 percent year-on-year.
However, market indicators for newly contracted rents, which are ahead of traditional statistical trends, show that rent inflation is below pre-pandemic levels, suggesting that the housing component of the price index will continue to slow over 2024-25, helping to lower overall inflation.