Will We End 2023 With 5% Inflation? Consumers Seem to Think So

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KEY POINTS

  • Inflation has been cooling since peaking in mid-2022.
  • There's a good chance inflation will get down to 5% this year, but that's not necessarily great for consumers -- and it's certainly not what the Federal Reserve wants.

That's not necessarily a good thing, though.

Most people are painfully aware that inflation has been a major problem for well over a year now. And since early 2022, many consumers have had to raid their savings accounts and rack up debt on their credit cards just to cover their basic bills, like housing, food, transportation, and utilities.

The good news is that inflation seems to be well past its peak. Last June, the Consumer Price Index (CPI), which tracks changes in the cost of consumer goods and services, measured annual inflation at 9.1%. Since then, the CPI has steadily declined. And as of February, the CPI was up only 6% on an annual basis.

Meanwhile, a Federal Reserve survey conducted in late 2022 had consumers pointing to inflation reaching the 5% point by the end of 2023. Based on the CPI drops we've seen thus far and where we're at today, that estimate is more than reasonable. But 5% inflation also isn't necessarily something to celebrate.

5% inflation is still very high

The Federal Reserve has been implementing interest rate hikes since early 2022 to combat inflation. And while much progress has been made, the central bank still feels it has work to do.

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In fact, consumers should gear up for more interest rate hikes in 2023 given that inflation is still at 6%. And even if inflation hits the 5% mark, the Fed won't be close to satisfied.

Generally speaking, the Fed likes to see annual inflation at around 2%. It's this level, the Fed feels, that lends to a strong economy and financial stability for consumers. But since we're nowhere close to that point -- not now, and not at 5% inflation, either -- we shouldn't expect the Fed to back down anytime soon.

Why interest rate hikes are such a problem

The Fed is not tasked with setting consumer interest rates for products like mortgages, auto loans, and credit cards. Rather, those rates are determined individually by lenders and credit card issuers.

But when the Fed raises its federal funds rate, which is the rate that banks charge each other for short-term borrowing, it tends to drive consumer interest rates upward, making it less affordable to borrow. This is intentional, because it will take a notable drop in consumer spending to bring inflation back down toward the 2% mark. But it also lends to a frustrating time for consumers who want or have to borrow money for different reasons, whether it's to buy a car or fix up an aging home.

In fact, consumers who are able to put off major purchases this year may want to go that route and wait for borrowing rates to come down. Signing a loan now will generally mean paying a lot more for it, and that unfortunately also applies to borrowers whose credit is excellent.

In time, inflation is likely to drop and the Fed is likely to back down on interest rate hikes. But we're nowhere close to that point. And we won't be there once inflation gets to 5%, either.

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