Inflation rears its ugly head again

No, we’re not done talking about the ‘I’ word quite yet. Today we learned that the inflation situation has gone from bad to worse:

• The Consumer Price Index report for May jumped 4.2% from a year ago. That’s the fastest pace inflation has accelerated in three years.
• Energy prices were the culprit, rising 3.9% over the month. Gas alone is up over 40% since last year.
• With food and energy prices removed, core inflation rose a tamer 2.9% annually, in line with expectations.

Economists were expecting inflation to climb because of the Iran war, which has spiked oil prices 35%. And unless the Iran conflict de-escalates quickly, “The broader and more persistent inflationary pressures are likely to become,” explained EY-Parthenon Chief Economist Gregory Daco in a note today.

This complicates the picture for the Federal Reserve. Right now, traders are betting the central bank will leave rates unchanged. “For a Federal Reserve already concerned about inflation persistence, another firm inflation report will strengthen the case for a more explicit two-sided reaction function,” added Daco.

Complaining all the way to the checkout

Logically, you’d think that higher inflation would stop people from paying up for expensive stuff. And people certainly say they’re fed up: Recent surveys of consumer sentiment show that shoppers are increasingly wary of an economic downturn.

So why is it that as companies are raising prices, many shoppers are compliantly continuing to pay more? Research from Goldman Sachs shows that shoppers have become less price-sensitive over time as incomes have risen. Plus, the gloomiest consumers aren’t the ones companies depend on, since the well-off do most of the buying (by Moody’s estimate, the top 10% of earners account for nearly half of all US consumer spending).

It’s the K-shaped economy in action: Plenty of Americans feel the squeeze, but top earners still aren’t bargain hunting. The result? According to Goldman, corporate profits as a share of value-added have doubled, from 5% in the 1980s to more than 10% recently. —LB