MNI INTERVIEW: Inflation Proves More Persistent -Fed's Garriga

Inflation is proving more stubborn than anticipated due to shifts in U.S. consumer spending patterns, a rosier European outlook and China's emergence from it zero-Covid policy, but there are scant signs that rising interest rates will cause a downturn this year, Federal Reserve Bank of St. Louis research director Carlos Garriga said in an interview Friday.

The U.S. central bank is set to respond to stronger data with a higher peak interest rate potentially held for longer, Fed Chair Jerome Powell said this week. Yet employers created nearly a million jobs in the first two months of the year reflecting robust labor demand, and that bodes well for economic activity overall, Garriga said.

"I’m cautiously optimistic first quarter growth will be revised to positive territory, that could eventually turn into a positive second half if inflation continues to drop," he said. But, "economic activity is not a strong predictor of inflation," and inflation has fallen less quickly than hoped.

"Most current estimates indicate we won’t get to the 2% target until mid-year 2024 or early 2025."

LABOR MARKET STRENGTH

Hiring in the leisure and hospitality sector continues to lead employment gains as U.S. consumers pivot back to spending on restaurants and travel, while firms in the St. Louis Fed region report a still-strong appetite to staff up due in part to high turnover, Garriga said. Employees are leaving not just for higher wages but more flexible work arrangements.

"Business contacts have a desire to scale but the challenge is the amount of turnover," he said, adding the trend may support employment growth for the near term.

China's reopening and a more optimistic European outlook "also factor into the inflation persistence we’ve been seeing," Garriga said.

"People want to socialize and travel, so you’re seeing demand that’s less sensitive to credit conditions," Garriga said. "You would expect a slowdown, but we’re going into the seasonal period of spring and summer. Global demand for services won’t dissipate anytime soon."

SOFT LANDING

Shifting spending patterns also mean inflation's road back to 2% is harder to predict and monetary policy transmission mechanisms are in flux, Garriga said.

"We have faster transmission in the financial sectors more sensitive to credit, but how that translates into other sectors that are less sensitive has changed," he said.

Investors have been more willing to get back into real estate, for example, as financial conditions eased earlier this year and mortgage rates retreated temporarily. The majority of homeowners were able to refinance during Covid and that's a wealth effect that boosts disposable income for those with a higher propensity to spend, Garriga said. That could fuel other parts of the U.S. economy.

Still, the Fed's restrictive policies and commitment to price stability mean inflation will come back down to earth, Garriga said.

"We can still have more than a soft landing, a positive outlook in which prices will moderate and eventually converge to target."