Why Is Inflation Stubbornly High?

Underlying inflation is close to 2%, while temporary energy, tariff, and supply-chain shocks keep reported inflation near 3.5% and should lead the Federal Reserve to raise rates only gradually.

• Average wage growth has remained near 4% and has moderated slightly despite low unemployment, easing concerns about a wage-price spiral.
• Productivity has averaged slightly more than 2% over the past three years, implying underlying price inflation of about 2% when set against 4% wage growth.
• Reported inflation is instead stuck around 3.5%, leaving an estimated gap attributable to exceptional factors rather than broad-based underlying pressure.
• The conflict in the Strait of Hormuz has reduced oil supplies, while tariffs and supply-chain disruptions have raised costs across goods and production networks.
• A one-off oil-price increase, such as a move from $60 to $100 per barrel, lifts inflation temporarily and fades from the data unless prices rise again.

Takeaway: The author expects the Fed to make one slow rate hike this year, probably at the December meeting, to demonstrate its commitment to the 2% target while waiting for temporary shocks to fade; wage inflation remains the key risk to this view.