Inflation - The Journey to 3%
Inflation - The Journey to 3%
The base effect and cooling month-over-month changes
Hey everyone, welcome to the first edition of the 5i Research newsletter. In this post, we will show some interesting facts behind the annual inflation numbers, and how a path to 3% can reasonably be achieved.
Let’s dive in!
The Importance of Month-Over-Month Inflation (MoM)
Month-over-month (MoM) inflation percentages are important because they help strip out and break down large spikes in inflation and get to the root cause of high inflation.
Below, we have created a timeline of the month-over-month US seasonally adjusted inflation numbers for 2022. By using a heat map on the numbers, we can immediately visualize that the largest month-over-month changes took place in the first six months of the year, and then cooled significantly in the last six months of the year.
If inflation continued at the rate it was heading in the first six months of the year, the annual inflation figure for 2022 would have been around 9.9%. Looking at the back half of the year, if we instead had those month-over-month figures carried out for the whole year, we would have seen an annual inflation rate of 2.9%.
2022 was a combination of an extremely hot inflationary environment in the first six months and a cool inflation environment in the back six months – ending up with a 6.4% inflation rate for 2022.
Average Month-over-Month Change
Contextualized in a different manner, the average month-over-month inflation increase for the first six months of 2022 was 0.8%. Looking at the last six months of the year, the average month-over-month inflation rate was 0.2%. Clearly, the US had a structural shift in inflation in the last half of 2022.
Forecasting Inflation for 2023
Shifting gears to what this means for the rest of 2023 if the month-over-month inflation numbers for the next four months are in line with what the average of the last eight months has been at 0.3%, the road to 3% is much more foreseeable. Let’s assume that for the next four months of 2023, month-over-month inflation numbers increase by 0.3%. By June, the annual inflation rate is ~3.6%.
We have created the below timeline to visualize how this takes place. The key to achieving a cool inflation reading by June is that as time progresses, the hot month-over-month increases from the first half of 2022 are knocked off (base effect).
Looking at the month-over-month inflation numbers is critical because as we have demonstrated, the annual US inflation rate for 2022 was 6.4%, however, the past eight months have witnessed a large amount of cooling. As the month’s progress and the high inflation readings from early 2022 are knocked off the 12-month inflation calculation, inflation readings have a high likelihood of coming in lower.
There is a chance that inflation re-accelerates, but we are giving it a low probability, especially considering the lagged effects from the housing market, one-third of the CPI index, has yet to break. We are not ruling out the possibility of higher inflation, but the road to 3% is within our grasp.
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