Gas prices have fallen. Here’s why inflation hasn’t

Martha C. White

Gas prices have been trending downward for more than 50 consecutive days, giving drivers some much-needed financial relief at the pump.

But nobody’s popping the champagne just yet. While gas prices have played a large role in the current bout of historic inflation, analysts warn that a number of factors remain that will keep overall prices from falling any time soon.

Oil outlook remains murky

Prices at the pump might be lower now — the average cost of a gallon of gas is down almost a dollar since the June peak — but the longer-term outlook for oil suggests low inventories that will keep prices elevated.

“Russia-Ukraine is a factor but… we had tight supplies coming into this,” said Rob Haworth, senior investment strategist at U.S. Bank Wealth Management. “We’d love to see the conflict in Russia and Ukraine end. But I think we still are faced with a global economy that is short of oil in the near term.”

Aside from Russia’s war with Ukraine and the sanctions that have disrupted its oil exports, the unwillingness — or inability, according to some oil analysts — of members of the Organization of the Petroleum Exporting Countries to significantly increase production is limiting how much additional oil is coming onto global markets. The oil group and its partners, known as OPEC+, last week announced a small output increase of 100,000 barrels a day for September, less than the market had expected.

One other factor is the hesitancy of US producers to sink big money into extracting and — more critically — refining fossil fuels when long-term policy goals suggest diminishing returns in the face of a shift to renewable energy.

“There is a structural problem with the oil and gas industry and that has to do with refining capability,” said Jeff Klearman, portfolio manager at ETF company GraniteShares. “Oil companies, not just in the United States but globally, have not expanded refining capacity. That continues to pressure gas prices.”

Peter McNally, global sector lead for industrials, materials and energy at investment firm Third Bridge, said there was “misunderstood criticism” of refiners’ swelling profits, pointing to investments being made to convert existing refining facilities to process biofuels. “These companies are investing for the energy transition,” he said.

Housing keeps getting pricier

Housing is a big part of the average family’s budget, and it’s also a big part of the basket of goods and services the government uses to calculate inflation. The way the Bureau of Labor Statistics calculates the cost of housing makes it a highly influential piece of the Consumer Price Index. Shelter costs include owners’ equivalent rent and rent of primary residence, which captures how much both homeowners and renters pay to live in their homes. Shelter comprises about a third of the overall CPI, and makes up around 40% of core CPI, which excludes prices for food and energy.

“What is important is housing,” said Sam Stovall, chief investment strategist at CFRA Research. “While we have been seeing new and existing home sales start to decline, prices have not been coming down because there’s still more demand than there is supply.”

Existing home prices hit a new record high of $416,000 in June, up 13.4% from a year ago. A February report from Realtor.com found that at the median, renters earning the typical household income for their area are paying nearly 30% of their income on rent, a threshold policymakers consider “rent-burdened.”

Also, the double whammy of higher prices and elevated mortgage rates continues to push homeownership out of reach for many, with more and more families forced onto the sidelines as the impact of the Federal Reserve’s aggressive rate hikes pushes up the cost of purchasing a home.

“Prices for housing will likely remain elevated and in a sense, keep high inflation higher for longer,” Stovall said.

Warped demand and worker shortages

Since the pandemic, a surge in demand for physical goods has thrown supply chains entirely out of whack, snarling logistics and triggering huge price distortions.

“Inflation is primarily caused by excessive demand chasing too few goods,” said David Dollar, senior fellow at the Brookings Institution.

This demand ran headlong into factory shutdowns in China, triggering cascading maritime traffic jams at Pacific ports. When vessels docked, there weren’t enough workers to unload the cargo or drive the trucks that would transport it first to warehouses, then to consumers.

“The overall demand for merchandise went up quite dramatically, so we were suddenly asking our system to handle a lot more stuff,” Dollar said. The result was chaos, and a sudden clamoring for workers — at any price.

“The lack of truckers reflects [that] we need more workers than we actually have, and that’s being resolved through higher wages,” Haworth said. As of June, there were more than three-quarters of a million additional workers in the transportation and warehousing sectors than before the pandemic.

Salaries and stimulus

Economists expect wage gains, which have been hovering at just above 5% on an annualized basis, to moderate through the rest of the year. But employers are still facing an acute shortage of workers, putting pressure on businesses to offer competitive salaries to attract and retain talent.

There were 10.7 million unfilled jobs in June, the BLS reported last week. While down from a record 11.7 million in April, that’s still almost two open positions for every American worker without a job.

“What we’re not yet clear about is, what is the new post-pandemic normal when it comes to demand? For now, it looks like wage pressures are here for a bit,” Haworth said.

That’s because unlike supply-chain snarls or even whipsawing commodity prices, inflation that creeps into wages is not easily undone. Even if companies can pay less for components or raw materials, they are unlikely to implement pay cuts, so inflation lingers.

“It’s highly correlated to wage growth. That’s not to say higher wages are a bad thing,” Haworth said. “When people have more money, they can buy more things. But if there’s not actually more things, prices go up. Ultimately, that does translate into some pressure for prices on everything else.”

Recent wage gains are coming on the heels of fiscal and monetary policies that contributed to an economy awash in liquidity as a result of stimulus payments to individuals and businesses, as well as quantitative easing by the Federal Reserve.

“They injected a ton of money into the system,” Klearman said. Like higher wages, all this cash — and too few goods to spend it on — is another contributor to price hikes consumers are experiencing on everything from cars to camping equipment to cookies.

Light at the end of the tunnel?

Despite expectations that inflation will likely stick around into 2023, there are some bright spots.

In addition to paying less to commute and run errands, Stovall says high-flying airfares could come back down to earth, and supermarket shoppers could see some grocery costs fall slightly if producers or distributors don’t have to pay as much for transportation in order to get their goods onto shelves. “You could start to see some food price competition start to enter the marketplace as the cost of transportation input starts to come down,” he said.

While supply chain snarls remain in some sectors — General Motors told investors on its quarterly conference call last month that it made 95,000 vehicles over the preceding quarter that can’t be finished, or sold, because the company can’t get the parts it needs to finish them — there is a sense that the earlier period of gridlock is easing.

There have also been some recent high-profile instances of retail markdowns: Walmart and Target both said they have had to slash prices to unload large amounts of unsold inventory that has lingered on shelves as Americans have shifted their spending back to services like dining out and live events.

There is also renewed, albeit uncertain, hope that President Joe Biden will roll back one or more tranches of the punitive tariffs Trump slapped on China in what experts agree was a largely failed bid to force Beijing to purchase more American agricultural products and other key exports.

An analysis by the Peterson Institute of International Economics estimated that, over time, rolling back Trump-imposed and other tariffs could pare inflation by as much as 1.3 percentage points, saving the average American household close to $800 a year.

“It would certainly be smart to remove the tariffs now,” Dollar said. “They’re not meeting any objectives and they’re being paid for by American households.”

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