Inflation should hit the Fed’s target in mid-2025, but prices are not coming down

According to the latest Consumer Price Index (CPI) update, inflation ticked up slightly from September to October but was still near its slowest pace since early 2021, when the economy was emerging from the pandemic-caused recession.

Inflation has slowed dramatically over the past couple of years and should continue to move lower in the near term. But lower inflation does not mean lower prices, and households will have to adjust to permanently higher prices post-pandemic.

At any point in time, some prices are going up and some are going down, but if most prices are going up there is inflation. There are different inflation measures, but the most widely cited is the CPI from the Bureau of Labor Statistics. It is weighted based on what consumers actually spend their money on, and what happens to the prices of those goods and services over time.

Although consumers usually think about inflation as it relates to goods, we spend more money on services — such as education, health care, housing and recreation — and the CPI reflects that.

Inflation peaked in 2022 at 9%, the highest rate since the early 1980s, due to strong consumer demand in the economy. Because of the pandemic, consumers couldn’t spend as much on services, so they spent much more on goods. Stimulus aid boosted incomes, allowing households to buy more. And the pandemic disrupted supply chains, making it more difficult for manufacturers in the U.S. and abroad to make goods and ship them to stores and buyers. The result was extremely high inflation.

Economists usually focus on the inflation rate, or how quickly prices are going up. But inflation is cumulative: If prices go up a lot one year, and again the next year, and still more the year after that, the price increases compound and they’re much, much higher at the end of the third year.

That’s what the U.S. economy has experienced over the past few years (as seen in Chart 1). If prices averaged 100 at the beginning of the pandemic, they now average 122, or a 22% increase.

The big jump is seen in the line rising very steeply in 2021 through 2023. And for some important and visible parts of the U.S. economy, the price increases are even steeper. For example, food prices and rents are both up 26% since the pandemic, according to the Bureau of Labor Statistics (BLS).

The good news is that inflation is going up less steeply now than it was a couple of years ago. Supply chain problems have faded, businesses have had a chance to catch up to stronger demand, and high prices have discouraged some buyers. Over the past year the CPI has increased by 2.3%. This is a little bit higher inflation than the pre-pandemic experience, and a little bit above the Federal Reserve’s inflation target — but it’s certainly a big step in the right direction.

Inflation should continue to ease in the months ahead, for a couple of reasons.

First, inflation was especially weak on a monthly basis in late 2023 and early 2024, making year-over-year comparisons more difficult. But those numbers will wash out of the data in the months ahead, reducing measured inflation.

In addition, rent growth is slowing and that is gradually working its way into the CPI. Rents surged in 2021 through 2023 as many young people formed new households and moved into the rental market. But since then, there has been a big surge in apartment construction, putting downward pressure on rents.

The Federal Reserve Bank of Cleveland produces an index that tracks rents as apartments are leased, and that measure shows a significant slowing in rental inflation. But rental inflation as measured in the CPI has slowed much less. This makes intuitive sense. Most people sign rental leases for a year. So if new rents are going up more slowly, that will only affect people who are signing leases at that point. It will take about a year for every tenant to sign a new lease and see their rent growth slow, and thus there is a big lag between changes in leases and changes in the rent component of the CPI.

But with lease inflation slowing, rental inflation is following suit. (That can be seen in Chart 2), where the change in the repeat rent index leads the rental CPI by about six months.

These two factors, plus high interest rates are leading to a cooling off in the labor market and slower wage growth. Inflation will continue to ease in the near term, and by the middle of next year inflation should be at the Federal Reserve’s 2% objective.

The central bank uses a slightly different inflation measure, the personal consumption expenditures price index excluding food and energy, but it moves in tandem with the CPI. If the Fed can get inflation to 2% without a recession, as it appears it will, they will have done a masterful job in achieving a “soft landing.”

But consumers will need to reset their expectations and recognize that prices will not return to where they were before the pandemic.

Gus Faucher is senior vice president and chief economist of The PNC Financial Services Group. He shares his insights on the regional economy each month.