US core consumer price momentum is likely to slow sharply in early 2022 but monetary trends appear inconsistent with inflation returning to its pre-pandemic level.
Headline and core (i.e. ex. food and energy) annual inflation rates rose to their highest levels since 1982 and 1991 respectively in November (6.8% and 4.9%) – see chart 1.
Chart 1
On a six-month rate of change basis, however, core momentum eased for a third month, albeit remaining high at 2.7% or 5.5% annualised – chart 2. Headline momentum was boosted by a further acceleration of food prices.
Chart 2
The moderation in core momentum mirrors a slowdown in six-month growth of broad money 14 months earlier – chart 3. The apparent relationship suggests a further significant fall in six-month core inflation.
Chart 3
A 14-month lead is notably shorter than the average in historical studies of the relationship between money and prices. The judgement here is that supply disruption due to the pandemic has accelerated the transmission mechanism.
While core momentum could slow faster than expected in early 2022, broad money trends argue against a return to the pre-pandemic level: core inflation averaged 2.0% over 2015-19. Six-month growth of the broad measure calculated here* is running at an annualised rate of about 9% versus a 2015-19 average of 5%.
Broad money growth is being boosted by strong expansion of commercial bank assets as well as ongoing QE. Adjusting for PPP loan forgiveness, banks’ lending book grew by about 9% annualised in the six months to November, with securities holdings rising by 18% – chart 4.
Chart 4
Banks are well capitalised and highly liquid but the October Fed loan officer survey suggested a cooling of credit demand – chart 5. Securities purchases, meanwhile, could slow as QE tapering and a rebound in the Treasury’s cash balance at the Fed following Congressional approval of a rise in the debt ceiling relieve upward pressure on bank reserves.
Chart 5
*M2+ = M2 + large time deposits at commercial banks + institutional money funds.