Demand-driven pressures grow as US inflation shifts

Demand is playing a larger role in US inflation, a shift that could influence the Federal Reserve’s approach to interest rates as it continues to assess price pressures in the world’s largest economy.

Demand-driven components contributed 1.2 percentage points to the 3.4 per cent annual rise in the personal consumption expenditures (PCE) price index in August. This was their largest contribution since September 2023, according to the figures provided.

Supply-driven factors contributed another 1 percentage point, while factors that could not be clearly classified as either demand- or supply-driven accounted for the remaining 1.2 percentage points.

The figures contrast with the inflation surge following the COVID-19 pandemic, when supply disruptions were a major source of rising prices.

In 2022, supply-driven components contributed an average of 3.1 percentage points per month to headline PCE inflation, compared with 2.6 percentage points from demand-driven factors.

The changing mix matters for the Federal Reserve because interest-rate rises can help cool demand by increasing borrowing costs for households and businesses. This can restrain spending and investment, easing some upward pressure on prices.

However, monetary policy has less direct influence over supply-side pressures, such as shortages, production disruptions and constraints on the availability of goods.

If demand continues to contribute more heavily to inflation, policymakers may need to weigh the risk of persistent price rises against the effects of keeping borrowing costs high. Higher rates can also slow economic activity and affect households and businesses.

The figures alone do not determine the Federal Reserve’s next move. Its decisions will depend on a wider range of indicators, including employment, consumer spending and subsequent inflation readings.

The latest breakdown points to a change in the forces behind US price growth, making it important for policymakers to assess not just how quickly inflation is rising, but what is driving it.