The day the US consumer price index drops below 2% will be a day of celebration. But Spain’s experience since reaching this coveted milestone suggests the Fed’s fight against inflation may not end there, highlighting the potential challenges a red-hot economy poses for both countries. I have to.
Data released this week showed Spain’s CPI rose 3.4% year-on-year in January, up from 3.1% in December and faster than economists expected. This is particularly surprising since the southern European country was an early winner in reducing inflation from a generational peak, posting an enviable figure of 1.9% in June.
Spain could benefit from a strong base effect, with gas and electricity prices falling sharply from June 2022 to 2023, immediately after Russia’s invasion of Ukraine, and the consumer price index falling below 2%. These forces conversely stimulated January’s surge, causing electricity prices to rise. And government energy support will be phased out.
Wouter Thierry, Spain economist at ING Bank, said high container prices related to tensions in the Middle East and other supply chain issues were also contributing to inflation, which was likely to continue in the coming months. do. Red Sea shipping disruptions target routes between Europe and China, but the United States may not be completely exempt from these pressures.
But a more important red flag for U.S. investors may be the impact of an overheating economy on inflation and interest rates. Data released this week showed Spain’s gross domestic product (GDP) grew at an annual rate of 2% in the fourth quarter of 2023, well above the 1.5% growth expected by economists. This reflects that the US itself achieved an impressive economic expansion of 3.3% in the last three months of last year.
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“More companies in Spain are planning to raise prices in the next three months, following a similar trend in other European countries,” said Thierry, citing official Spanish data. I am. “This is linked to the strong GDP report. Spain’s strong economic momentum makes it easier for companies to raise prices.”
ING expects the Fed to return inflation to 2% before Spain, but Thierry expects similar inflationary pressures to take hold given such strong growth in the U.S., with CPI rising above 2% again. He said he would not be surprised if it could be exceeded.
Even if U.S. inflation trends downward in the coming months, the Fed could still pose a problem given the red-hot economy and risks spurring price increases through other channels, such as interest rate cuts or asset bubbles. be. This view is the opposite of those who think the Fed has been slow to raise interest rates in response to inflation and will be slow to cut them — that the U.S. economy is getting worse.
Stephen King, senior economic adviser at HSBC Bank, said: “Cutting rates simply because inflation is low without considering the pace of economic growth is only asking for trouble.”
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I wrote this in my recent notes.
This reminds us of the similarities between today’s stock market’s record highs on artificial intelligence hype and the tech bubble of the late 1990s.
In 1998, the Federal Reserve responded to the financial market turmoil by lowering interest rates, but GDP growth in the middle of that year was a solid 3.8%. “Fed’s ’emergency’ interest rate cut” [then] “We mistakenly poured financial gasoline on the fire of the ‘new economy’ with rapidly rising asset prices,” King wrote.
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We all know what happened next. The Fed reversed its interest rate cuts in 2000, and the stock market went into free fall. “The same risks could be materializing today,” King wrote.
Write destination Jack Denton (jack.denton@barrons.com)