Despite Inflation Rate Falling to its Lowest Point in 2 Years, Expect the Fed to Hike Interest Rates Again this Year

The US inflation rate reached its lowest point in June since its unforgettable and meteoric rise which began in 2021 in the wake of lockdowns, quarantines, and economic stimulus packages around the world. This drop in 12-month consumer price growths reached 3%, consistent with forecasts that had the 4% rate in May dropping to 3.1%. This marks the 12^th consecutive month that inflation has gone down since it reached 9% in June 2022, however, it is the first time it has dropped in a month that was not preceded by interest rate hikes from the Federal Reserve.

This is an encouraging sign for the US inflation rate and for the Fed, who has set a goal of 2% for inflation to reach. While the Consumer Price Index (CPI) saw a slight increase from May to June, from 0.1% to 0.2%, that number is down 0.4% over the previous 3 months. Gas prices have led the way in dropping inflation, with average prices from $4.66 dropping to $3.54 in the last year, along with decline in grocery costs and used car prices. However, it is important to note that the Core Index, which does not account for food and energy costs and many consider a more precise barometer, dropped 5.3% to 4.8% from May to June, despite it being forecasted to go up by 5%.

There has been endless debate among economists and other experts as to the cause for the sudden, radical inflation we have seen over the last couple years, and why it has been so difficult to bring the rate of inflation down. During the height of Covid the market saw increased spending on consumer items while people were spending more time at home and shopping online. Omair Sharif of Inflation Insights has identified two primary perpetrators for inflation in the used car market and high airfare prices. The auto industry in general has been hit hard by inflation, largely due to supply chain issues with parts and to a lesser extent labor issues. However, it is the notoriously high prices of used cars that have been especially impactful, which are now showing signs of stabilizing with a 0.5% decrease. Airlines have seen a great increase in demand recently along with very high prices for jet fuel, though those prices have started to come down. Air carriers have begun using larger planes and offering additional flights to big destinations to help remedy these issues.

Some also attribute blame to the 3 rounds of stimulus checks doled out by the US during that time, with many believing the Biden stimulus package in ’21 may have intensified the rise in inflation; however, this rise in inflation was also seen globally, even in countries with less intense economic stimulus. The Fed has also faced criticism for their response to the increase in inflation in ’21. They denied the pressure of inflation at the time and continued with low interest rates more suitable for post-inflation. However, they have since responded with action in the last year, and it just might be working.

The Fed Chairman Jerome Powell, since he was up for renomination and his eventual reappointment last year in May, has been much more aggressive in how the Fed has been combatting inflation. Dating back to March 2022, they have raised their key interest rate by a hefty 5%, the steepest incline of interest rate hikes in over 40 years, bringing it within a range of 5-5.25% presently. The Fed elected to not hike interest rates further last month in an attempt to monitor the effects of their previous actions, along with the Central Bank’s own interest rate hikes, on the economy as it generally takes time for them to manifest. While these signs are promising the Fed has indicated they intend to raise interest rates again at the end of this month, which many experts believe may be the last hike necessary this year, although the Fed has hinted at another bump in September, which could bring the key rate as high as a range of 5.5-5.75%.

With as much debate as there has been concerning the cause of inflation, there is equally as much with regard to what is next for the economy with all of these signs of change. While there are a number of economists who have reason to believe the current trends will persist and perhaps not even the July hikes may be necessary, the Fed has been consistent in the belief that more aggressive hikes are necessary to reach their goal of 2% inflation, and that may be reinforced as so far, they have been working.

There are also many, both inside and outside the Federal Reserve, who believe that the goal for lowering inflation cannot be accomplished without the job market taking a hit or pushing ourselves into a recession. Unemployment numbers saw a spike during Covid, but due to economic support from the government it has been able to remain steady for now. However, some believe that continuing to hike interest rates may put pressure on the job market and may push the economy into recession and that inaction at this point may allow a very rare achievement of lowered inflation without recession. And there are yet others, who believe that further heightening of interest rates may be the answer to avoiding recession.

Regardless of whether the Fed decides to hike rates yet again, there is relative assurance that those rates will be lowered back down to a 4.6% benchmark rate, though those projections generally show a weak economy albeit with lowered inflation. Prices have also been stabilizing and in some cases even falling recently, which further gives cause for hope the light at the end of the tunnel may be nearing. The answer, at the end of the day, is that it’s still too early for us to tell. For whatever it may be worth, the initial reaction on the stock market when the news broke of the lowered inflation rate was positive, with all 3 major indexes up in response. Let’s hope that everything else keeps trending that way, with the exception of costs.

Implications for Internal Auditors Amidst Declining US Inflation Rate

• Heightened Focus on Economic Forecasting: With the US inflation rate experiencing significant fluctuations over the past couple of years, internal auditors will need to place greater emphasis on accurately forecasting economic trends. Understanding the factors that contributed to the rise and subsequent drop in inflation can help auditors better anticipate potential risks and vulnerabilities within their organizations.
• Reevaluating Investment Strategies: The recent decline in inflation may prompt organizations to reevaluate their investment strategies. As inflation rates impact the overall purchasing power of money, internal auditors should work closely with financial teams to assess the potential effects on investment portfolios and financial planning.
• Evaluating Risk Management Protocols: The unpredictability of inflation rates and their potential impact on various sectors underscore the importance of robust risk management protocols. Internal auditors should collaborate with risk management teams to identify and assess the risks associated with changing economic conditions and ensure appropriate measures are in place to mitigate them effectively.
• Monitoring Supply Chain Risks: Supply chain disruptions were cited as one of the contributing factors to inflationary pressures. Internal auditors should closely monitor supply chain risks, assess vulnerabilities, and recommend contingency plans to minimize disruptions and ensure smooth operations.
• Scrutinizing Impact on Prices and Costs: As inflation rates stabilize and even decrease in some sectors, internal auditors should analyze the implications on prices and costs within their organizations. This analysis will be crucial for businesses to adapt to changing economic conditions and maintain their competitiveness in the market.
• Staying Updated on Federal Reserve Actions: The Federal Reserve's response to inflation, including interest rate adjustments, can significantly influence economic conditions. Internal auditors should closely monitor the actions taken by the Federal Reserve and consider their potential impacts on their organization's financial strategies and performance.
• Enhancing Compliance and Reporting: Fluctuating inflation rates can have ripple effects on financial reporting and compliance requirements. Internal auditors must ensure that their organizations adhere to the latest regulatory guidelines and accurately report financial information amid changing economic conditions.
• Remaining Adaptable: The uncertainty surrounding inflation rates and the broader economy requires internal auditors to remain adaptable and responsive to emerging challenges. Being proactive in identifying risks and opportunities will enable auditors to help their organizations navigate evolving economic landscapes successfully.
• Collaborating with External Experts: As the inflation landscape evolves, internal auditors may benefit from collaborating with external economic experts to gain deeper insights into potential risks and opportunities. Expert opinions and forecasts can supplement internal auditing efforts and provide a broader perspective on economic trends.

The recent decline in the US inflation rate presents both challenges and opportunities for internal auditors. By closely monitoring economic trends, evaluating investment strategies, and enhancing risk management protocols, auditors can play a vital role in guiding their organizations through changing economic conditions and maintaining financial stability.