Unexpected Inflationary Twist: Trump’s Tariffs Initially Curbing Price Hikes
Recent inflation reports are presenting a seemingly paradoxical picture, with some analysts suggesting that the very tariffs implemented by former President Donald Trump are, in the short term, contributing to a moderation in price increases. While the long-term expectation remains that these import levies will fuel inflation as businesses pass on added costs to consumers, the current economic climate paints a more complex scenario.
Ryan Sweet, chief U.S. economist of Oxford Economics, posits that the tariffs, by triggering global recession fears and dampening American consumer spending, particularly on certain services, are acting as a temporary inflation suppressant. This effect stems from the uncertainty surrounding the trade environment, leading to a contraction in international trade and a more cautious approach to spending among consumers.
However, the prevailing sentiment among economists is that this temporary respite from inflation is hardly worth the potential long-term economic damage that could arise from a full-blown trade war and subsequent economic downturn. The concern is that while inflation may appear under control in the immediate future, the underlying economic fundamentals are being weakened, potentially leading to more severe consequences down the line.
This peculiar situation also presents a challenge for Federal Reserve Chair Jerome Powell. With inflation figures appearing benign, it becomes more difficult to justify the Fed’s decision to hold off on interest rate cuts, especially if the labor market shows signs of weakening. This is further complicated by Trump’s continued criticism of Powell and his calls for lower interest rates, adding political pressure to the Fed’s decision-making process.
The impact of the tariffs is already visible in recent economic data. The consumer price index (CPI) revealed that overall inflation dipped to a five-month low of 2.4% in March, while the core measure, which excludes volatile food and energy prices, fell to 2.8%, the lowest level since March 2021. On a monthly basis, inflation was practically flat.
While the trade war isn’t solely responsible for these favorable inflation readings, it’s believed to be a contributing factor. Other elements, such as tumbling used car prices and the smallest increase in rent since January 2022, also played a role. Additionally, the high inflation rates observed in early 2023 made for more favorable year-over-year comparisons in early 2024, further contributing to the perceived slowdown.
However, the inflation-dampening effects of the tariffs are projected to persist, and possibly even strengthen, in the upcoming April and May CPI reports. Economists surveyed by Bloomberg predict that overall inflation remained steady at 2.4% last month, while Barclays estimates it edged down to 2.3%, the lowest since February 2021. The core measure is expected to have remained at 2.8%.
Beyond tariffs, other forces are also at play. The easing of the bird flu crisis has significantly lowered wholesale egg prices, which could have translated into lower retail prices, after significant increases in previous months.
The primary mechanism through which tariffs are curbing inflation is by slowing trade and fueling global recession concerns. This, in turn, has pushed down U.S. crude oil prices from around $80 a barrel in January to approximately $60 recently. This decline isn’t solely attributable to the tariffs, as OPEC’s decision to increase oil production also contributed.
The decline in oil prices has had a direct impact on gasoline prices, which fell by 6.3% in March and are estimated to have dipped another 0.4% last month. Lower gasoline prices provide direct relief to consumers and contribute to lower overall inflation.
Furthermore, the trade war has discouraged foreign travel to the U.S., particularly from Canada. While U.S. household spending has generally remained robust, consumers are beginning to cut back on discretionary spending, such as vacations. Reduced demand, coupled with lower jet fuel costs due to falling oil prices, has spurred airlines to cut fares.
Airline fares fell 4% in February and 5.3% in March, and Barclays estimates they declined another 2% in April. These declines are unusual, as airfares typically rise in the spring in anticipation of the summer travel season. The decline is therefore likely attributed to weakened consumer sentiment and concerns about the economic outlook.
Another factor contributing to the temporary inflation dip is the performance of the stock market. The fees charged by investment companies, which are based on a percentage of client holdings, contributed to inflation when the stock market reached record highs. The recent market volatility, driven by tariff-related concerns, has tempered these fees.
While these financial service fees don’t have a significant impact on the CPI, they do influence the personal consumption expenditures (PCE) price index, which the Fed monitors closely.
Overall, Sweet estimates that these effects could constrain annual inflation by approximately three-tenths of a percentage point in the near term.
However, both Sweet and Barclays economist Pooja Sriram anticipate that the inflationary pressure from tariffs will intensify in the coming months. Sweet predicts that tariffs will start pushing up prices for used cars and other items as early as June, while Sriram believes the acceleration will begin in July. Both economists expect core inflation to rise to approximately 4% by the end of the year.
Therefore, while the recent inflation reports may appear encouraging, they are likely a temporary phenomenon. The long-term impact of Trump’s tariffs is expected to be inflationary, as businesses pass on increased costs to consumers.
