Higher Energy Prices Cause Inflation Measures to Accelerate and Consumers to Reduce Real Consumption

Key Takeaways:

• The Consumer Price Index (CPI) jumped 1.2 percent in March, the largest one-month gain since September 2005, according to the Bureau of Labor Statistics (BLS). On an annual basis, prices were up 8.5 percent, the fastest pace since 1981 and an acceleration of six-tenths from February. The headline gain was driven by surging energy prices, which increased 11.0 percent. Airline fare jumped 10.7 percent, in part due to high oil prices and rebounding demand. Both rental prices and owners’ equivalent rent were up 0.4 percent, a deceleration of two tenths from February for the former and flat growth for the latter. Excluding food and energy costs, core CPI increased 0.3 percent over the month and 6.5 percent over the year. Though a marked deceleration for core CPI, this was heavily influenced by a 3.8 percent drop in used car and truck prices, the largest single month decline for that category since 1969.
• The Producer Price Index (PPI) for final demand of goods and services rose 1.4 percent in March, the largest monthly gain since the series began in 2010, according to the BLS. Annually, producer prices rose 11.2 percent, also a series record. The gain was driven in part by a 5.7 percent jump in energy prices and a 2.4 percent gain for food, though services prices also rose a robust 0.9 percent. Core PPI (less food, energy, and trade services) increased 0.9 percent in March, an acceleration of seven-tenths from February, and was up 7.0 percent annually.
• Retail sales and food services rose 0.5 percent in March, according to the Census Bureau. On the positive side, food service sales rose 1.0 percent, furniture store sales increased 0.7 percent to mark their third consecutive monthly gain, and electronics and appliance store sales moved up 3.3 percent. Due to higher prices at the pump, sales at gas stations rose 8.9 percent. Nonstore (online) retailers continued a volatile streak as sales fell 6.4 percent, and motor vehicle and parts dealers continued to struggle, with sales dropping 1.9 percent. Core retail sales (excluding food services, autos, building supplies, and gas stations) declined 0.1 percent.
• The Fannie Mae Home Price Index, a newly released national, repeat-transaction home price index measuring the average quarterly price change for all single-family properties, excluding condos, rose 20.0 percent on an annual basis in Q1 2022, the fastest annual pace in the 47-year history of the series.
• The National Federation of Independent Business (NFIB) Small Business Optimism Index declined for the third consecutive month, falling 2.5 points to 93.2, the lowest level since 2016 when excluding the COVID-induced April 2020 decline. On net, a negative 49 percent of firms expect the economy to improve, a decline of 14 percentage points, and negative 18 percent of firms expect real sales to be higher, a decrease of 12 percentage points. On net, 72 percent of firms are increasing selling prices, an increase of 4 points and a series record, while 49 percent of firms are increasing worker compensation, also an increase of 4 points. 31 percent of firms rate inflation as their single most important problem, a gain of 5 percentage points from February.
• The University of Michigan Consumer Sentiment Index rose 6.3 points to 65.7 in the preliminary April reading, breaking a three-month streak of declines but remaining at the second-lowest level since the economic recovery began. The gain was driven by a 9.8-point jump in consumer expectations for the future, while consumers’ evaluation of current economic conditions rose 0.9 points.

Forecast Impact:

The March inflation reports were heavily impacted by the energy price spike caused by the Russian invasion of Ukraine. Since then, oil prices have pulled back significantly, which will provide some relief to the energy and gasoline components in April, and this decline was likely one of the drivers in the increase in consumer sentiment in April. On an annual basis, we expect that the CPI has peaked in March due to stronger annual base effect comparisons from 2021, expected future price stabilization in energy, and expected declines in auto and some other durable goods prices. However, we don’t expect month-over-month core inflation to cool dramatically in the near term. Though core CPI increased at the slowest rate in six months, this was driven primarily by a larger-than-expected (and likely unsustainable) drop in used car prices. Underlying inflationary pressures, such as shelter costs, continued to climb at the same 0.5 percent rate as in February, in line with our forecast, and we expect wage pressures from the historically tight labor market to continue to feed through to consumer prices, which was evident again in the NFIB survey showing almost half of firms raising worker pay and nearly three-in-four increasing selling prices. Further, core producer price increases, which are thought to partially pass through to consumer prices, showed no signs of slowing. Considering the underlying details of this month’s reports, our inflation forecast will likely be largely unchanged.

We believe the Fed will act aggressively to combat rising prices, meaning a 50-basis point hike in the federal funds rate and the commencement of the balance sheet runoff are both likely in May. We’ve stated previously that the exact impact of policy tightening on long-term rates is difficult to predict, but thus far the Fed’s more hawkish tone has prompted an unusually sharp jump in mortgage rates, which hit 5 percent this week, according to Freddie Mac’s latest primary mortgage market survey. This is likely to weigh dramatically on housing activity this year and slow home price growth, and we are likely to downgrade our forecasts for new and existing home sales.

When considering price increases, real retail sales in March were weak. However, this weakness was partially offset by upward revisions to both the January and February figures, and the growth in nominal spending at restaurants and bars relative to other retail is an encouraging sign for the services industry. Still, when combined with consumer sentiment still at its lowest level since 2011, it’s clear that consumer spending is softening, consistent with our forecast for a significant slowdown in personal consumption growth in Q2.

Nathaniel Drake
Economic and Strategic Research Group
April 15, 2022

Opinions, analyses, estimates, forecasts, and other views of Fannie Mae's Economic and Strategic Research (ESR) Group included in these materials should not be construed as indicating Fannie Mae's business prospects or expected results, are based on a number of assumptions, and are subject to change without notice. How this information affects Fannie Mae will depend on many factors. Although the ESR group bases its opinions, analyses, estimates, forecasts, and other views on information it considers reliable, it does not guarantee that the information provided in these materials is accurate, current, or suitable for any particular purpose. Changes in the assumptions or the information underlying these views could produce materially different results. The analyses, opinions, estimates, forecasts, and other views published by the ESR group represent the views of that group as of the date indicated and do not necessarily represent the views of Fannie Mae or its management. .