Why did US inflation post its biggest jump since April?

If you've been keeping tabs on inflation, the latest numbers might be giving you whiplash. The Federal Reserve’s key inflation gauge—the core Personal Consumption Expenditures (PCE) index—rose by 0.3% in December, marking its largest increase since April. Year-over-year, PCE inflation advanced 2.6%, marking the biggest gain in seven months. This signals that inflation isn’t ready to throw in the towel just yet, and businesses, consumers, and policymakers need to stay on their toes.

The Road to Today’s Inflation

Inflation has been a persistent economic force, shaped by various factors over time. In the 1970s and early 1980s, inflation hit double digits, fueled by excessive money supply growth and oil crises. More recently, the pandemic era led to massive supply chain disruptions and a surge in government stimulus, sending inflation soaring to 8.3% in 2022.

Source: Statista.com

Although inflation eased throughout 2023 due to aggressive Fed rate hikes, December’s core PCE surge suggests that inflationary pressures remain. The latest uptick in inflation is linked to factors like rising wages, stubborn housing costs, and resilient consumer spending. Carl Weinberg, Chief Economist at High-Frequency Economics, noted, "The Fed's prognosis is for a slower pace of monetary easing moving forward, as the economy is doing well and prices are only slowly returning to target in an environment of great uncertainty."

Why Inflation is Heating Up Again

After months of cooling, why is inflation ticking back up? Here are a few culprits:

• Wage Growth: While higher wages are great for workers, they increase labor costs for businesses, which often pass those costs onto consumers.
• Housing & Energy Costs: Despite some relief at the gas pump, overall energy costs are creeping up again, and housing costs remain persistently high.
• Consumer Spending Strength: Shoppers haven’t slammed the brakes just yet, with spending rising 0.7% in December, the fastest growth pace in nearly two years. The savings rate, however, has dropped to 3.8%, its lowest in two years, suggesting consumers are dipping into savings to keep up with rising costs.

What This Means for Businesses

Businesses are facing rising costs in wages, raw materials, and energy. Those who haven’t adjusted pricing may soon need to. Industries like retail, food, and manufacturing may feel the squeeze more than luxury and service-based businesses, which have more pricing power.  Long-term planning is becoming more complex, as inflation uncertainty makes it harder for businesses to forecast costs and set pricing strategies. While consumer demand remains strong, businesses need to balance competitiveness with profitability.

"We expect consumer spending will continue to be bolstered by strong balance sheets overall, including record amounts of housing wealth," said Nancy Vanden Houten, Lead U.S. Economist at Oxford Economics. The labor market remains tight, with employment costs rising 0.9% in the fourth quarter. While layoffs remain low, jobless claims recently fell to 216,000, the lowest since May. The Employment Cost Index (ECI), a key Fed inflation measure, rose 3.8% year-over-year, indicating businesses are still adjusting wages to attract and retain workers. Under Trump’s policies, labor costs could rise further due to reduced foreign labor availability, which could put upward pressure on wages and inflation.

The Fed’s Strategy

With inflation still above the Fed’s 2% target, the central bank is playing it safe. Despite market expectations for multiple rate cuts in 2024, the Fed held rates steady in January and indicated that cuts aren’t coming until at least mid-year. Why?

• Resilient Economy: Consumer spending and employment data suggest the economy isn’t slowing down as much as expected.
• Core Inflation Still Sticky: The 2.8% year-over-year rise in core PCE is keeping the Fed on high alert.
• Avoiding Policy Missteps: Cutting rates too soon could reignite inflation, making it even harder to tame in the long run.

Fed Chair Jerome Powell reinforced this cautious stance, stating, "We are watching 12-month inflation closely because that takes out the seasonality issues that may exist."

The Government Shift

With Trump back in the White House, all eyes are on how Trumponomics 2.0 will reshape taxes, trade, and technology in 2025. His administration has already signaled potential tax cuts, new tariffs, and a focus on deregulation—all of which could have inflationary consequences. Historically, tariffs on imports have led to price increases for goods, impacting both businesses and consumers.

Additionally, proposed corporate tax cuts could encourage investment but may also fuel inflation if consumer spending surges in response to increased disposable income. Tighter immigration policies could further constrain the labor market, driving wages and inflation higher.

Inflation’s Not Done Yet

December’s inflation spike is a reminder that we’re not out of the woods. Businesses need to stay proactive—monitoring costs, adjusting pricing strategies and preparing for ongoing Fed rate decisions. Whether inflation continues its rollercoaster ride or stabilizes will depend on a mix of consumer behavior, business strategies, and policy decisions in the months ahead. With Trump’s return, a shifting economic agenda, the Fed’s cautious approach, and fiscal policy uncertainty, the next few months will be critical in determining whether inflation is here to stay or finally on its way down. The economic landscape remains uncertain, making the coming months crucial in determining inflation’s trajectory.