US wholesale inflation data maintains pressure on Fed to keep rates high

Producer prices in the US rose more than expected in January, reinforcing concerns about the stickiness of inflation that may prompt the Federal Reserve to keep interest rates higher for longer to cool the economy.

The producer price index, often regarded as a leading indicator of where consumer inflation is headed in several months’ time, rose 0.7 per cent last month from December, the US Bureau of Labor Statistics said on Thursday. That surpassed economists’ expectations for a 0.4 per cent increase.

On an annual basis, the PPI, which tracks prices paid to US producers for goods and services, was up 6 per cent from a year ago. That marked a moderation from 6.5 per cent in December, but came in well above market forecasts for 5.4 per cent.

The PPI figures come days after consumer price data showed inflation slowed only slightly in January. Recent jobs growth and retail sales have also been resilient despite the Fed’s efforts to cool the economy with high interest rates, which it this month raised to a range of 4.5 per cent to 4.75 per cent.

Almost a fortnight ago, a blockbuster non-farm payrolls report showed the US economy added more than half a million jobs in January and the unemployment rate fell to a 53-year-low of 3.4 per cent. Days later, Fed chair Jay Powell warned rates might have to be raised higher than investors expected because the strong labour market meant it could take longer for inflation to return to the central bank’s 2 per cent target.

Prior to the release of the jobs data at the start of February, futures markets expected the central bank’s key rate to peak just below 5 per cent, and were pricing in two 0.25 percentage point interest rate cuts by the end of the year. Investors now expect that rate to peak around 5.25 per cent, and have roughly even odds of one cut or no cuts by year-end.

US stock and government bond markets sold off on Thursday following the PPI data, as well as figures that showed the number of Americans filing for jobless claims last week remained near historical lows.

The S&P 500 closed 1.4 per cent lower, having managed on Wednesday to take stronger than forecast retail sales data in its stride. The yield on the interest rate-sensitive two-year US Treasury rose 0.02 percentage points to 4.64 per cent, keeping it close to a three-month high struck in the previous session.

“I think Powell put it aptly last week when he said the difference between the Fed’s outlook and the market’s was mainly a difference in how fast each thought inflation would decelerate,” said Guy LeBas, the chief fixed-income strategist at Janney Montgomery Scott. “On the margin, the January CPI tilted the argument slightly in the Fed’s favour and away from the market’s, but only slightly.”

Adding to evidence about the strength of the domestic labour market, new applications for state unemployment aid, a proxy for lay-offs, totalled 194,000 in the week ending February 11 on a seasonally adjusted basis. That was down from the revised 195,000 the previous week, the labour department said on Thursday.

Weekly jobless claims have remained below 200,000 since mid-January. The last time that applications remained below that threshold for such an extended period was in April 2022.

Fed governor Michelle Bowman last week said that even though some components of inflation had moderated, continued labour market tightness was putting upward pressure on inflation.

Other parts of the economy are feeling the pinch of higher rates, though. Data on Thursday showed the rate of new home construction in the US fell to the lowest level since the early stages of the Covid-19 pandemic as higher mortgage rates have weakened demand. Separately, an index of manufacturing activity tracked by the Philadelphia branch of the Fed tumbled to a reading of minus 24.3 in February, its lowest level since May 2020.

The combination of the producer price and consumer price inflation reports this week “suggests the easy battles against price pressures have been won”, said John Lynch, chief investment officer at Comerica Wealth Management.

“The move from 9 per cent to 6 per cent will prove to be much less challenging than the journey from 6 per cent to 3 per cent,” Lynch said of price inflation levels.