If inflation rises, forget about interest rate cuts

The views and opinions expressed are solely those of the author.

Recently, Federal Reserve Chairman Jerome Powell said that with the inflation rate falling and the labor market cooling, interest rates have likely peaked. He also added that the Fed could cut interest rates three times next year and perhaps four times by 2025. The investment community welcomed this news as the stock market soared to new highs. But will these rate cuts happen?

Powell notes that the annual inflation rate, which peaked at 9.1% in June 2022, has fallen steadily. Powell says the rapid rise in interest rates that began in June 2022 and ended last summer led to the dramatic drop in inflation.

Over the past four months, the annual inflation rate, as measured by the consumer price index, has remained below 4% and now stands at 3.2%, which is close to Fed's 2% target. Powell also noted that the Fed was able to achieve this without any significant increase in the unemployment rate, which is currently below the 4% target that economists would call a full-employment economy. Powell says the economy will experience a soft landing.

All of this may be true and welcome. But a closer look at the numbers reveals that all is not as good as it seems. It also shows that interest rate cuts expected for next year may not happen.

Lower interest rates are not only welcomed by Wall Street, but also by Main Street. Too many potential home buyers have been forced out of the housing market simply because with mortgage rates at 7% or 8% and home prices constantly rising, they couldn't afford the monthly payments .

Consumers also welcome lower interest rates because they use their credit cards more than ever. Last summer, for the first time ever, total US consumer credit card debt topped $1 trillion and continues to climb. Average credit card interest rates are now over 20% and in some cases as high as 30%.

The Fed will cut interest rates as predicted by Powell if the inflation rate continues to fall. While this may happen, there is a chance that inflation will not fall and may actually rise.

Most of the decline in the CPI since June last year was due to falling energy prices. These prices fell because global demand is falling, especially as China's economy slows to recover from the fall shutdown in 2022. Other global economies are slowing. In addition, rising energy prices in 2021 and 2022 led to an increase in supply from some producers.

If energy and food prices remain constant, the core annual inflation rate today is 4%, much higher than the current CPI. The core inflation rate has remained in the 4% to 5% range for more than two years.

There are several factors that influence energy prices. With war breaking out in the Middle East and Iranian-backed militias aggressively attacking oil tankers traveling in the Persian Gulf, there is a chance that some oil may not make it to product markets. This could push oil prices up significantly.

If oil prices start to rise while the core inflation rate remains at 4%, we could see the overall inflation rate rise into the 5% range. In this case, the Fed would not lower interest rates and, in fact, could raise them even further.

The other factor that could push the inflation rate higher is the big wage increases that the workforce has negotiated for next year and, in many cases, for the next three years. Many organized labor contracts have called for wage increases of up to 7% per year.

Other unorganized workers see the big increase in wages and start demanding more. Salary increases will average more than 4% next year. Since productivity is less than 2%, this large wage increase will put upward pressure on prices that will contribute to more inflation.

It looks like the economy is finally slowing down. After growth of more than 2% in the first half of this year and 5% in the third quarter, most economists expect growth of 1% in the current quarter. Even slower growth is forecast for next year. This puts pressure on the Fed to lower interest rates.

But with price stability as the main goal, the sluggish economy will not be enough to keep interest rates low if inflation rises.

We hope for the best for next year.

Dr. Michael Busler, Ph.D. is a public policy analyst and professor of finance at Stockton University, where he teaches undergraduate and graduate courses in finance and economics.

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