Though cooling prices over the last period left room for optimism, Wednesday's US Consumer Price Index report might bring the heat again.
With inflation up 0.6% month over month in August, the overall measure of prices for a broad range of goods and services is now 3.7% more than a year ago. The high price of energy commodities, including a spike in gasoline prices, accounted for over half of the increase in the overall inflation rate.
This jump in inflation, the biggest monthly gain this year, indicates that prices are still rising at a pace above the Federal Reserve's 2% annual target rate.
"The slight increase in core CPI suggests that we might not be in the clear," said Jon Maier, chief investment officer at Global X. "And if these numbers continue to grow, the Fed might reconsider its stance on interest rates."
When the inflation rate hit 8.5% in March 2022, the Fed set off an aggressive sequence of interest rate hikes in an attempt to slow down the economy and curb prices by reducing consumer borrowing. Now, 11 rate hikes later, the cost of everyday essentials has fallen considerably but not enough. The key question is whether the Federal Reserve has maxed out on interest rate hikes or if more are necessary to keep inflation in check. For now, experts anticipate the central bank will take a pause at next week's Federal Open Market Committee meeting.
Inflation isn't something that can be tackled overnight, and it's still taking a toll on US households and consumers. Here's a quick primer on the state of inflation and steps you can take to prepare for what's ahead.
What is inflation?
Inflation means your dollar bill doesn't stretch as far as before, whether at the grocery store or a used car lot. "Inflation refers to the increase in the prices of goods and services over time," said Xavier Epps, CEO of XNE Financial Advising.
Inflationary pressures happen over time and require historical context to understand. For example, in 1993, the average cost of a movie ticket was $4.15. Today, watching a film in the theater will easily cost you $13 for the ticket alone, never mind the popcorn, candy or soda. A $20 bill 30 years ago would buy someone more than double what it buys today. And while wages have also risen over the past few decades, they haven't kept up with inflation. Consumers have less purchasing power.
That becomes a concern when high prices are out of control and require a slowdown of economic activity to tame them, which can sometimes, though not always, trigger a recession.
What does the latest CPI report reveal?
Inflation rose 3.7% year over year in August, while core inflation (which excludes the volatile prices of food and energy) rose at an annual rate of 4.3%.
The spike in energy costs paints a dreary picture once again. Energy prices increased in August by a whopping 5.6% month over month, including a 10.6% increase in gasoline prices.
"Energy price inflation has been the key driver of the post-pandemic inflation flareup, spilling over into transportation and commodities most directly, and pulling everything else up with it," Julia Pollak, chief economist at ZipRecruiter, said in a post on X (formerly Twitter).
The influence of energy prices on inflation is an age-old story, capable of interfering with even the strictest and most well-orchestrated monetary policy by the central bank, according to Kurt Rankin, senior economist at the PNC Financial Services Group.
Rankin noted that the steady increase in oil prices over the last several months has put upward pressure on consumer prices. At the same time, what's driving inflation is not limited to higher prices at the pump, he noted.
This month's CPI report indicated that housing and rent costs, which make up a significant part of the core inflation calculation, continue to weigh heavily -- the shelter index has shot up 7.3% over the last year. "The continual increase in the shelter index and the fluctuation in transportation indexes, especially used cars, will play pivotal roles in shaping policy decisions," Maier said.
But market watchers suggest the Fed plans to proceed with caution at next week's policy meeting and keep rates steady at the 5.25% to 5.5% range, according to David Donovan, vice president of financial services at Publicis Sapient. Donovan notes that the Fed's stance is to monitor data and wait until there's been a sufficient slowdown in economic growth before making any substantial policy changes.
How do we know we're in a period of high inflation?
Inflation affects everyone differently, and it's not determined by observation. It's backed by a consensus of experts who rely on market indexes and research.
One of the most closely watched gauges of US inflation is the Bureau of Labor Statistic's CPI, which tracks data on 80,000 products, including food, education, energy, medical care and fuel. The BLS also puts together a Producer Price Index, which tracks inflation from the perspective of the producers of consumer goods, measuring changes in seller prices in industries like manufacturing, agriculture, construction, natural gas and electricity.
There's also the Personal Consumption Expenditures price index, a broader measure prepared by the Bureau of Economic Analysis, which includes all goods and services, whether they're bought by consumers, employers or federal programs on consumers' behalf.
The current inflationary period started back in April 2021, when consumer prices jumped at the fastest pace in over a decade, causing a stir among market watchers. Inflation was originally thought to be temporary while economies bounced back from COVID-19.
But as months progressed, supply chain bottlenecks persisted and prices skyrocketed. The US was then hammered by unanticipated shocks to the economy, including subsequent COVID variants, lockdowns in China and Russia's invasion of Ukraine, leading to a choked supply chain and soaring energy and food prices. The cost of gasoline prices was a big contributor to inflation in 2022.
After reaching a peak rate of around 9% last summer, inflation is now at 3.7%. Although that's still high, experts believe we're in a state of "stayflation," where inflation will remain in the 3% to 4% range unless there's an official recession.
How are the Federal Reserve's rate hikes tied to inflation?
The Fed moderates inflation and employment rates by managing the money supply and setting interest rates. Part of its mission is to keep average inflation at a steady 2% rate.
"As inflation rises, the Fed has to try to control it. Really, the only tool that the Fed has in order to do that is raising policy rates," said Liz Young, head of investment strategy at SoFi.
When the Fed increases the federal funds rate -- the interest rate banks charge each other for borrowing and lending -- it restricts how much money is available to borrow and spend, which has an impact on economic growth. Banks pass on rate hikes to consumers, meaning everything from credit card APRs to interest rates on personal loans tick up. Consequently, this can drive consumers, investors and businesses to pause their investments, leading to a rebalance in the supply-and-demand scales.
In general, when interest rates are low, the economy and inflation grow. And when interest rates are high, the economy and inflation slow.
What does inflation mean for you?
Periods of high inflation make it harder to afford everyday essentials. Interest rate hikes mean it costs more for businesses and consumers to take out loans, so buying a car or home gets more expensive. As interest rates increase, liquidity in securities and cryptocurrency markets decreases, causing those markets to dip. Credit card debt and other forms of high-interest debt have also become more expensive over the last year.
Though inflation has been easing for the past few months, it's still unpredictable. There's never a guarantee that it will continue to trend downward, and there's still a chance of more Fed rate hikes this year.
In the current period, experts recommend trying to chip away at debt the best you can. One option is a debt consolidation loan that could combine any high-interest variable debt into a lower-interest, fixed-rate loan and establishing a payoff plan. Getting a balance transfer card can also help you avoid high interest for a period of time. If the economy continues to be volatile, it's also important for households to build up a financial cushion.
While inflation has been stubborn, there's one financial advantage to increased rates: Many CDs, high-yield savings accounts, money market accounts and treasury bonds are offering annual percentage yields, or APYs, at around 4% and 5% -- the highest savings rates seen since the 1990s. Experts recommend taking advantage of putting your funds in one of these accounts to get a bigger return on your balance. The interest you earn can help you reach your emergency fund or sinking fund goal faster.