The Mystery of Inflation: A Year of Surprises

Just a year ago, inflation seemed to be slowing quickly and hopes grew that the Federal Reserve could soon throttle back its interest-rate hikes. Then the Fed — and Wall Street — got punched in the face.

A Shocking Revelation

These updates rarely make waves. This time, they did.

The new information in February 2023 showed that inflation hadn’t slowed nearly as much as previously believed. To make matters worse, the next two monthly inflation readings were bigger than expected.

“That was a complete game changer,” Ellen Zentner, the chief economist at Morgan Stanley, told . “It changed the landscape for inflation as we thought and as the Fed thought.”

As a result, the Fed kept raising a key short-term U.S. interest rate to try to slow the economy and tame inflation. The Fed’s moves pushed up other interest rates, including for mortgages, and crushed would-be home buyers.

The Uncertainty Looms

Could it happen again? The next annual update to the CPI will be released Feb. 9 — and economists and Fed officials are on guard.

“Having got burned on that, I want to see those revisions,” Zentner said. “Maybe it’s a nothing burger.”

Fed governor Chris Waller is another official who is keen to see the CPI update.

“Recall that a year ago, when it looked like inflation was coming down quickly, the annual update to the seasonal factors erased those gains,” he said two weeks ago. “My hope is that the revisions confirm the progress we have seen, but good policy is based on data and not hope.”

Inflation Update: Lingering Effects & Future Expectations

Every year, the Bureau of Labor Statistics diligently updates inflation data for the preceding five years, taking into account new and improved information. Typically, these changes are so subtle that they go unnoticed by the general public.

However, last year was an exception.

In December 2022, the three-month annualized rate of inflation experienced a significant increase, jumping from 3.1% to 4.3%. This sudden change did not go unnoticed.

The primary factor behind this drastic shift was the underestimation of price hikes in the automobile industry. Both new and used car prices reached unprecedented levels in 2022 and 2023, making a substantial contribution to the highest inflation levels the United States has seen in four decades.

Fortunately, economists predict that history will not repeat itself this time around. In fact, it is expected that the annual revisions will indicate a slightly faster deceleration of inflation compared to previous reports.

According to Ryan Sweet, the chief U.S. economist at Oxford Economics, "The upcoming annual revisions to the consumer-price index, covering data from 2019 through 2023, will likely be modest but should show that inflation was on a better trajectory heading into this year than thought."

Assuming there are no surprises in February, it is highly likely that the Federal Reserve will remain steadfast in its plan to reduce U.S. interest rates by early or late spring. This news comes as a relief to potential home buyers, car purchasers, and borrowers in general.

As per the latest Consumer Price Index (CPI) report for December, the yearly inflation rate stood at 3.4%, while the Fed's target is to maintain a 2% annual pace of inflation.

The January CPI report, slated for release in a few weeks, is expected to demonstrate further inflation deceleration. However, January can be a tricky month as many companies traditionally increase their prices at the beginning of the year, occasionally resulting in an unexpectedly sharp rise in inflation.

Greg Robb contributed.