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Inflation and Wages Continue to Climb Rapidly, in Bad News for the Fed

Economic data on Friday brought troubling news for Federal Reserve officials who are trying to rein in the fastest inflation in decades: Prices are still rising quickly. Wages are rising rapidly too. And the strong consumer demand that is helping to fuel the inflationary fire shows little sign of letting up.

The data, from two separate government reports, wasn't a surprise, and included hints of progress. But it was confirmation of the challenges facing policymakers, and further evidence that their aggressive efforts to constrain the economy are taking time to have a significant effect.

The Fed's preferred measure of inflation, the Personal Consumption Expenditures price index, climbed by 6.2 percent in the year through September, in line with the increase the month before, the Commerce Department said Friday. After stripping out food and fuel, which can be volatile from month to month, prices increased by 5.1 percent over the past year, a brisker increase than the 4.9 percent in the year through August.

Both of those inflation measures are rising faster than the 2 percent rate that the Fed targets on average and over time.

As central bankers try to predict when inflation will slow, they are watching for any sign that the labor market is loosening up and that rapid wage growth is moderating. It would be difficult for inflation to decelerate with pay climbing at the pace it has recently. Companies facing heftier labor bills generally try to pass at least some of those cost increases on to consumers.

The Employment Cost Index, a quarterly inflation measure from the Labor Department that tracks changes in wages and benefits, climbed by 1.2 percent from June to September, matching what economists in a Bloomberg survey had expected.

The index picked up by 5 percent on a yearly basis, down slightly from 5.1 percent in the previous report. In the decade leading up to the pandemic, that figure averaged 2.2 percent yearly gains, underscoring how rapid today's rate is.

A measure that tracks wages and salaries in the private sector showed a more pronounced slowdown, which some economists greeted as a hopeful sign. Even so, the upshot was that pay growth, while showing some hints of moderation under the surface, remains unusually rapid.

"The level of wage growth is still very high, even if it is moving in the right direction," said Laura Rosner-Warburton, a senior economist at MacroPolicy Perspectives. "It's probably putting upward pressure on services inflation."

The Fed meets next week, and it is almost uniformly expected to announce an increase in interest rates of three-quarters of a percentage point on Wednesday. Officials have previously indicated in economic forecasts that they expected to slow to a half-point rate increase in December, and investors will closely watch the post-meeting news conference held by Jerome H. Powell, the Fed chair, for any sign that such a step down is imminent.

Officials have been clear that they will at some point stop raising rates but that they then plan to leave them at a high level for some time. The idea is that the high rates would continue to weigh on economic growth, slowing the economy and reining in inflation while hopefully avoiding a severe recession.

Friday's inflation data will probably do little to change the central bank's views. Officials already knew that inflation continued to run fast last month, because the related but more timely Consumer Price Index showed a rapid pickup in September when it was released in mid-October.

But the fresh third-quarter wage data could influence policymakers' thinking, at least at the margin. Fed officials closely monitor the Employment Cost Index because it avoids some of the data pitfalls that afflict other wage measures, including monthly average hourly earnings numbers. Those figures tend to move around as the composition of the work force shifts: For instance, if a lot of low-wage workers leave jobs, the hourly earnings measure can spike suddenly.

Last year, Fed officials specifically cited the third quarter's Employment Cost Index data -- which came in very strong -- as a major reason for shifting their stance toward more rapidly withdrawing support from the economy.

Friday's figures are likely to reaffirm to officials that even as rate increases weigh on the housing market and stoke fears of a recession, it will take more time to dampen the labor market.

It takes months or even years for Fed policy to have its full effect on the economy, because rate increases set off a chain reaction: As it becomes more expensive to borrow, consumer spending on big-ticket items and business investments in expansion slow down. Demand wanes, hiring slows and the labor market eventually cools off. As that happens, wage growth should also slow, further weighing on demand.

Fed officials face a major challenge as they try to gauge whether their policy changes so far will be sufficient to cool down the overheating job market, which has very low unemployment and far more job openings than workers.

While there are signs of nascent slowing -- including the measure of wages and salaries in Friday's data, and recent declines in job openings -- most indicators suggest that the labor market remains unusually hot.

The fresh employment cost data "doesn't show much slowdown just yet in strong wage growth, even if we're seeing it in other measures," Omair Sharif, the founder of Inflation Insights, wrote in a research note after the release.

If officials cannot bring the labor market back into balance, it could be hard to slow demand enough to constrain inflation -- and allowing price increases to continue unabated for a long period is risky. Consumers could begin to expect consistently higher costs, factoring that into wage negotiations, as companies institute regular and large price increases. This shift in expectations could make fast inflation a more permanent part of the American economy.

Friday's report underscored that for now, demand remains strong. Consumer spending rose 0.6 percent in September as Americans continued to open their wallets for cars, gifts and especially travel and other in-person experiences that many people missed out on earlier in the pandemic. Spending in September modestly exceeded forecasters' expectations, and the government revised up its estimate for spending in August, more evidence that the Fed has not yet managed to rein in demand.

The resilience of the American consumer has been clear in recent corporate earnings calls, even as firms worry that the Fed's rate increases will eventually weigh on shoppers. American Express, the credit card company, is looking forward to a robust holiday season as consumers shift their spending toward services.

"As we sit here today, we see no changes in the spending behaviors of our customers, and our credit metrics continue to be strong with delinquencies and write-offs remaining at low levels even as loan balances are steadily rebuilding," Stephen J. Squeri, the company's chief executive officer, said on an Oct. 21 earnings call.

Mr. Squeri said that the company saw reason to expect continued momentum.

"The holiday season from a travel perspective looks really, really strong because people are booking three months out," he said. "And if you're going to be traveling, you're probably going to be going to restaurants. And if you're traveling in some place, you're probably bringing presents with you as well. So we don't see anything really changing over the next three months."

Still, it is unclear how long Americans can keep up their spending. Despite the strong wage gains, overall personal income barely kept pace with rising prices in September. Many families are spending more by saving less: Americans saved 3.1 percent of their after-tax income in September, less than half as much as they were saving before the pandemic.

[Source: By Ben Casselman and Jeanna Smialek, The New York Times, 28Oct22]

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