Inflation really impacts you so prepare yourself!

On June 14, 2017, US Federal Reserve Chairwoman Janet Yellen and all but one of her central bank colleagues voted to raise its benchmark federal-funds rate by a quarter percentage point to between 1% and 1.25% thus representing the 3rd increase in the past year and a half. (See Federal Reserve Press Release). In addition to lifting this key U.S. interest rate, the Fed laid out a plan to shrink its massive $4.5 TRILLION balance sheet starting “this year”.

These two moves reflect the Fed’s view that an economic expansion now entering its 9th year no longer needs to be propped up so much. The aim of these moves is to raise the cost of borrowing for consumers and businesses to ensure the economy does not overheat and spark a bout of inflation.

Part of the reason for yesterday’s rate increase is the Fed’s concern about an increase in price pressures that accelerated toward the end of 2016. Current data, however, indicates the rate of inflation over the past 12 months has slowed to 1.9% in May from a 5-year high of 2.7% just 4 months ago. Annual inflation is now running just below the Federal Reserve’s goal of 2%.

In fact, the cost of goods and services for American consumers fell in May for the 2nd time in 3 months as inflation continued to recede from recent highs. In May, a 6.4% drop in gasoline prices contributed substantially to this change. In addition, the slowdown in inflation is also attributed to less rapid increases in the cost of rent, homes and medical care.

The cost of food, however, increased for the 5th straight month; a stripped-down measure of inflation that excludes the volatile food and energy categories rose 0.1% in May. The 12-month rate of core CPI fell to 1.7% from 1.9% in April.

This more recent softening trend might give the Fed some wiggle room to continue to raise interest rates at a gradual pace. In fact, most economists predict just one more rate hike this year in the short-term fed funds rate if inflation remains contained; the short-term rate can have a big impact on the cost of borrowing since many business and consumer loans are tied to changes in fed funds.

Sometimes all this talk about changes in interest rates and inflation do not resonate with the typical consumer. That is when it might be a whole lot easier to understand the impact of inflation on earnings and savings when a visual image is provided. Have a look at what you could buy for $1 between 1900 and 1910 and what $1 would buy after 2010. Puts things in perspective for me!

The Buying Power of the U.S. Dollar Over the Last Century

The Buying Power of the U.S. Dollar Over the Last Century

Courtesy of: Visual Capitalist