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Why We Expect Inflation to Fall in 2024

Wondering when inflation will go down? We’re optimistic about what’s ahead.

For now, it looks like inflation will return to normal without a recession.

We expect inflation’s effect to fade through the end of 2023 and into 2024 after it reached its highest level in over 40 years in 2022.

In our latest Economic Outlook, we detail that the drop in inflation is driven principally by the unwinding of price spikes owing to supply chain resolutions, along with a moderated pace of economic growth resulting from the Federal Reserve’s tightening.

We expect inflation to average 1.8% from 2024 to 2027—undershooting the Fed’s 2% inflation target.

But if inflation proves stickier than expected, the Fed stands ready to induce a recession to bring inflation down to 2%.

PCE Inflation (%)

Data as of Oct 9, 2023 Bureau of Economic Analysis, Morningstar

Headline Inflation Has Plunged Since Mid-2022

Personal Consumption Expenditures Index inflation,which is our (and the Fed’s) preferred inflation measure, has fallen from a peak of 7.0% year-over-year in June 2022 to an estimated 3.3% as of July 2023.

Consumer Price Index inflation, which uses a narrower definition of household consumer expenditures, has fallen even more dramatically year over year. It had peaked at higher rates owing to a higher weighting in energy.

The decline in core inflation has been less impressive, but that’s starting to change.

Inflation Measures, % Growth Year Over Year

A line chart showing year-over-year inflation for the CPI and PCE indexes.

Sources: Bureau of Economic Analysis and Bureau of Labor Statistics.

Categories That Have Played an Outsize Role in Excess Inflation

The postpandemic jump in inflation began with only a handful of spending categories.

When excess inflation (the difference from where inflation stood before the pandemic) was at its highest in the second quarter of 2022, the inflation rate was 6.8%. Durable goods, energy, and food at home accounted for 70% of that excess inflation, despite being only 20% of total consumption.

Since then, inflation has spread to several other categories. These other categories, which include housing, vehicles, and more, now account for about half of excess inflation. Still, the partial deflation in these categories has helped slow the overall inflation rate substantially. And, with prices in these categories still way above their prepandemic trends, there’s room for much more deflation in coming years.

PCE Excess Inflation by Category

% contribution to cumulative excess inflation vs. fourth-quarter 2019.

A line chart of the Personal Consumption Expenditures Index's excess inflation by category.

Source: Bureau of Economic Analysis.

Where We Expect Inflation to Fall the Most Over 2023-27

Given the role of industry-specific supply shocks in driving inflation, we take a bottom-up approach to forecasting inflation for the next five years. That is, we start by examining the underlying components and work toward macro trends.

Here’s where we expect the greatest drop in inflation (and sometimes outright deflation) between 2023 and 2027:

  1. Durables: Major supply constraints are lifting. In particular, the semiconductor market is likely to flip from shortage to glut over the next few years. The normalization of spending patterns (shifting back to services) is also easing pricing pressure on goods. We expect about one third of the excess inflation in durables to unwind by 2027.

  2. Food and energy: We expect prices to subside as the industry adjusts to disruption from factors such as the Ukraine war, and they’re already starting to fall due to broad supply chain relief.

  3. Housing: Housinginflation has accelerated markedly over the past year, but we don’t expect this to last. It’s already starting to fall in response to moderating rents.

In all other components of the Personal Consumption Expenditures Index, we expect moderate wage growth and the absence of any long-lasting supply disruptions to keep inflation at restrained levels. And the economy growing well below potential through 2024 will cause widespread deflationary pressure.

PCE Inflation Forecast: Key Components (% Growth)

A line and bar chart showing the key components of the Personal Consumption Expenditures Index's inflation forecast.

Sources: Bureau of Economic Analysis and Morningstar.

Supply Chain Healing Will Bring Goods Prices Down

Numerous production and logistical disruptions have contributed to inflation in durables and other parts of the economy. But supply chains are healing as demand normalizes and capacity catches up: The Federal Reserve Bank of New York’s Global Supply Chain Pressure Index is even showing looser supply chain conditions than before the pandemic.

Global Supply Chain Pressure Index (New York Fed)

A chart illustrating that the Federal Reserve Bank of New York's Global Supply Chain Pressure Index is even showing looser supply chain conditions than before the pandemic.

Source: Federal Reserve Bank of New York.

There’s more help on the way. One indicator on the logistics side is that there are enough container ships set to be delivered over the next several years to expand the current fleet by 30%. And manufacturing capacity is expanding in the United States and other major economies, such as China.

Other key takeaways about supply chains include:

  1. Supply chain improvement won’t be fully reflected in lower prices right away, just as core goods prices didn’t peak until about a year after supply chain paralysis set in. But in addition to moderating prices for consumer goods, we’re already seeing producer prices upstream of consumer prices starting to deflate.

  2. Transport costs are falling sharply owing to lower fuel prices and a burgeoning logistics glut.

  3. Retailers’ gross margins are still quite high, but competitive pressures should bring them back down to size over the next several years.

Housing Market Inflation in 2023 and Beyond

Because price indexes capture the cost of living, and most people don’t sign a new lease or buy a new house every year, it takes time for housing prices in price indexes to capture changing market conditions. For this reason, CPI inflation is still running fairly hot owing to the accumulated runup in market rents since 2021.

That said, here’s where the housing market currently stands:

  1. Market rents are now decelerating sharply, in response to falling housing demand. Rent growth fell to only about 3% year over year as of July 2023, from about 15% as of May 2022. This is causing CPI shelter to finally decelerate, which we expect to persist over the next year until housing inflation returns to normal.

  2. After 2023, we expect home prices to remain flat. We expect weak home demand will continue to weigh on housing prices and eventually converge most of the way back to the prepandemic trend. This will return the CPI shelter index to normal.

  3. Lower housing prices will also aid in returning housing affordability to more reasonable levels. From a cost perspective, lower home prices should become more palatable for builders as easing supply constraints reduce the cost of construction inputs.

A Soft Landing Is Our Base Case

Our base case is that inflation will return to normal in 2024, even as real gross domestic product growth remains positive in year-over-year terms—a “soft landing.”

Over the past year, inflation has fallen around 300 basis points even as real GDP growth has accelerated. That performance has defied the predictions of those in the stagflation camp, who thought that a deep economic slump would be needed to root out entrenched inflation. Instead, the inflation-GDP trade-off has been very kind, thanks to the loosening of supply constraints, as we had long anticipated.

Still, we’ve been surprised by the resiliency of economic growth in the face of aggressive rate hikes from the Fed. This means the “overheating” scenario has increased in probability, where the economy grows at a rollicking pace and inflation remains in the 3%-4% range.

We still think that the Fed’s rate hikes executed thus far will eventually slow GDP growth sufficiently and that inflation will drop to 2% (while avoiding an outright recession). The effects of these rate hikes are still accumulating throughout the economy as borrowers roll over to higher interest rates and exhaust their financial cushions.


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