Posted: 10 Jun. 2020 5 min. read

US inflation drops, Federal Reserve holds the line on rates and maintains highly stimulative policy

The US Consumer Price Index posted a decline of 0.1 percent in May from the month prior, causing inflation to decelerate to a mere 0.1 percent. Lower energy prices were a key part of the story, dropping 1.8 percent in the month, and down nearly 19 percent from a year earlier. However, prices for auto insurance, apparel, and airline fares all recorded significant declines. Unsurprisingly, prices fell in sectors most affected by the lockdown. In contrast, food prices rose 0.7 percent in May. I think there is a clear trend here. Prices for essential goods or those that are consumed at home are rising with vendors gaining pricing power. But, prices for non-essential goods or those involving personal contact are declining. The low inflation will lead some to fret about deflation. But, I do not believe that it will take hold. The reopening of the economy will lead to stronger economic growth, and deflation risks will abate alongside. Having said that, the substantial economic slack should keep inflation under wraps during the recovery.

Given the low inflation environment and the prospects for a slow recovery, it is no surprise that the FOMC, the policy setting body within the US Federal Reserve, elected to leave interest rates unchanged today. The Fed also committed to increasing its bond buying program at the current pace in the months to come to help support the flow of credit to households and businesses.

The Federal Reserve is forecasting an economic contraction of 6.5 percent in 2020 with a recovery of 5 percent in 2021. These projections are presented as year-over-year as of the fourth quarter, not the annual averages often quoted. It suggests that the return to the pre-COVID-19 level of economic activity will take until 2022. The Fed’s inflation projection was lowered to 0.8 percent in 2020, but the monetary authority sees inflation accelerating to 1.6 percent in 2022.

The FOMC expects to keep rates are current levels for more than two years. Only two members predicted a higher fed funds rate by the end of 2022.

The OECD also published its revised global outlook, receiving considerable attention given its choice to present two distinct forecasts arguing their equal probability. If there is no second wave of infection, the world economy is expected to contract 6 percent this year but post growth of 5.2 percent in 2021. If there is a second wave of infection, the OECD projects a 7.5 percent decline in 2020 and a tepid 2.8 percent recovery in 2021. While we can quibble over the probability of the second wave, the OECD’s approach reinforces our view that businesses and governments need to think about scenarios.

Economic Insights

A regularly updated snapshot by Deloitte Economics that provides commentary from Chief Economist, Craig Alexander on the latest developments shaping Canadian and international economies including, economic growth, business investment, trade, and market activity. Deloitte analysis gives you the knowledge to tackle the most challenging business issues of today.

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Craig Alexander

Craig Alexander

Chief Economist and Executive Advisor

Craig Alexander is the first Chief Economist at Deloitte Canada. He has over twenty years of experience in the private sector as a senior executive and leading economist in applied economics and forecasting. He performed macroeconomic research, regional and sector analysis, and fiscal market forecasting and modelling. Craig is a passionate public speaker and holds a graduate degree in Economics from the University of Toronto.