- On 12 July it was reported that US inflation had fallen to 3% in June, the lowest level since 2021.
- Markets welcomed that the end of rate rises seemed close.
- Inflation of 3% means prices are still rising, though more slowly: lost purchasing power does not recover by itself.
On 12 July 2023 it was reported that US inflation had fallen to 3% in June, the lowest level since 2021. Markets welcomed that the end of rate rises seemed close. After months of very high readings, the figure marked an evident change of pace.
The change of scenario mattered because inflation is one of the factors that most influence central bank decisions and, by extension, the cost of financing for companies and families. Even so, the figure needed a careful reading, because a lower percentage does not tell the whole story of what has happened to prices. For those who had lived through the months of sharpest rises, the figure brought a breather, but it also raised a basic question: how much of the accumulated inflation had already become embedded in incomes, rents and contracts.
Good news with nuances
Markets reacted well for a simple reason: if prices moderate, the central bank has less reason to keep tightening its policy, and that brought the end of rate rises closer.
The logic is simple. Central banks raise rates to slow demand and, with it, prices. When inflation approaches its target, the reason for keeping up that pressure disappears and the door opens to a more neutral policy. But prudence suggests waiting for the data to confirm the trend over several months. Inflation figures are published monthly and each one is a piece of a larger puzzle. Central banks prefer to wait for several consecutive readings to confirm the direction before changing their policy.
More stable prices, not cheaper ones
The fall in inflation did not mean that prices went back, only that they were rising more slowly. It is a common confusion: inflation of 3% shows that prices are still getting dearer, albeit at a slower pace. The general price level remained permanently higher than before the surge.
For a household or a company, the difference is fundamental. Relief in the rate does not translate into lower bills, but into bills that grow less quickly. The prices that shot up in the preceding years were still there, and any budget had to start from that level, not from the one before the episode began. A practical consequence is that comparisons with earlier years must be made with care. An expense that looks stable in nominal terms has lost purchasing power, and an income that has not grown has lost real value.
Purchasing power
The purchasing power lost in 2022 did not recover by itself. Salaries, rents, contracts and budgets that had not been updated were still paying the cost of that rise. Savings held in cash, moreover, had lost real value while prices rose.
It is worth checking whether one’s own income, and that under long-term contracts, keeps pace with prices, and whether cash savings hold their real value. For companies, that includes rate-update clauses; for families, comparing the evolution of their income with that of the cost of living. It is an exercise best done calmly and with real figures. For companies with multi-year contracts, this suggests reviewing when and how rates are updated, and checking whether the update formula reasonably compensates for the cost increases accumulated since signing.
Easing inflation is not the same as undoing the accumulated rise in prices.
This article is general information. It is not legal, tax or investment advice, and it does not take anyone’s particular circumstances into account.
