Inflation is cooling, but high prices will stick around

Inflation may cool. However, for most Americans, the price of a cup of coffee or a bag of groceries has not risen.

In the coming months, the big question is whether consumers will feel the same relief.

In the past few months, many of the key factors that led to four-decade high inflation have begun to dissipate. Shipping costs have dropped. Cotton, beef and other commodities have been cheaper. And shoppers are finding deeper discounts online and in malls during the holiday season, as retailers try to get rid of excess inventory. Consumer prices fell 0.1% in December compared to the previous month, according to the Labor Department. This marked the biggest monthly decline in nearly three years.

But lower freight and commodity costs won’t immediately trickle down to consumers, in part because of supplier contracts that set prices months in advance.

Prices are still well above where they were a year ago. The headline consumer price index, which measures the cost of various goods and services, rose 6.5% in December, according to Labor Department data. Some of the price increases are very noticeable: The cost of large Grade A eggs has doubled, while the price tag for cereal and bread products has increased by 16.1%.

“There are some prices, some things that are falling in value,” said Mark Zandi, chief economist at Moody’s Analytics. “But in general, prices are not falling. It’s just that the rate of increase is slowing down.”

Retailers, restaurants, airlines and other companies decide whether to cut prices or impress investors with better profit margins. Consumers are becoming more selective about spending. And economists are weighing whether the U.S. will enter a recession this year.

At the start of the Covid pandemic, Americans continued to spend at the same time that factories and ports were temporarily closed. Container clogged up port. Stores and warehouses are struggling with non-existent merchandise.

Increased demand and limited supply lead to higher prices.

Now, that factor is starting to reverse. As Americans feel inflation and spending on other priorities such as commuting, traveling and eating out, they have been buying cheaper things.

Freight costs and container costs have been reduced, reducing prices in the rest of the supply chain. Costs for long-haul trucking rose 4% in December compared with the year-ago period, but were down nearly 8% from a record high in March, according to Labor Department data.

The cost of a 40-foot container fell 80% from a peak of $10,377 in September 2021 to $2,079 in mid-January, according to Drewry’s World Container Index, a supply chain advisory firm. But it’s still higher than pre-pandemic rates.

Food and clothing have become cheaper. Wholesale beef prices fell 15.6% in November compared to a year ago, but are still at historic highs, according to the U.S. Department of Agriculture. Coffee beans fell 19.7% in the same period, according to the International Coffee Organization’s combined global prices. The cost of raw cotton fell 23.8%, according to Labor Department data.

However, to protect against unpredictable price spikes, many companies have long-term contracts that set the prices they must pay to operate their businesses months in advance, from purchasing materials to moving goods around the world.

For example, Chuy’s Tex Mex locked in prices for beef fajita that are lower than what the chain paid last year, and plans to also lock prices for ground beef during the third quarter. But diners will likely pay higher menu prices than last year.

Chuy’s plans to raise prices by about 3% to 3.5% in February, although there will be no further price increases later this year due to its conservative pricing strategy. The chain’s prices are up about 7% compared to the same period last year, following price increases in the restaurant industry as a whole.

Also, coffee drinkers won’t see a drop in the price of lattes and cold drinks this year. Netherlands Bros. Coffee CEO Joth Ricci told CNBC that most coffee businesses hedge their prices six to 12 months in advance. He predicted that coffee chain prices could stabilize from mid-2023 and finally at the end of 2024.

Supplier contracts are not the only reason for sticky prices. Labor is increasingly expensive for businesses that need a lot of labor but find it hard to find. Restaurants, nail salons, hotels and doctors’ offices will still face higher wage costs, Moody’s Zandi said.

The shortage of airline pilots is one factor that will keep prices high this year. Airline ticket prices have fallen in recent months but are still up nearly 30% from last year, according to the latest federal data.

But, Zandi said, if the labor market remains strong, inflation eases and wages rise, Americans can better manage higher prices for airline tickets and other goods.

Annual hourly earnings have risen 4.6% over the past year, according to the Bureau of Labor Statistics — not as high as the consumer price index in December.

But in some categories, reduced demand has translated into price relief. Some hot pandemic items, including TVs, computers, sporting goods and major appliances have declined, according to Labor Department data from December.

Top retail executives say family budgets will remain under pressure next year.

At least two store executives, Hook CEO Rodney McMullen and Sprout Farmers Market CEO Jack Sinclair, said they do not expect food prices to go down anytime soon.

“The increase is starting to moderate a bit,” McMullen said. “That doesn’t mean you’re going to start seeing deflation. We’re going to expect inflation in the first half of the year. The second half of the year will be lower.”

He said there are some exceptions. Eggs, for example, will become cheaper as the bird flu outbreak recedes.

For the past two years, consumer packaged goods companies have either raised the prices of items on Kroger’s shelves or reduced the size of packages, a strategy known as “shrinkflation.” McMullen said no one has returned to stores to lower prices or increase discount levels from a year ago. Some keep pricing aggressively, because they roll after margins were squeezed before the pandemic or when they sacrificed volume for profit, he said.

At Procter & Gamble, for example, executives plan to increase prices again in February. Prices on P&G’s consumer staples like Pampers diapers and Bounty paper towels rose 10% from a year earlier, while demand fell 6% in the most recent quarter.

In other cases, companies are still dealing with factors that cause inflation. For example, farmers are raising cattle, but fewer than before the pandemic, and less wheat and corn as the war in Ukraine continues, according to McMullen.

“If before you spent $80 and now you spend $90 [on groceries]I think you’re going to spend $90 for a while,” he said. “I don’t think it’s going to go back to $80.”

Brand Utz CEO Dylan Lissette echoed that sentiment back in August, telling investors that list prices usually don’t fall even if costs drop.

“We don’t take something that’s $1, go to $1.10 and then a year or two later, go to $1,” he said.

However, food companies such as Utz typically offer steeper and more frequent discounts to customers as costs fall, according to Lissette, who once priced Utz’s pretzels and kettle chips.

Over the next few years, the company may reverse the “shrinkflation” packaging changes that have resulted in cheaper snacks per ounce. And two or three years after that, buyers can see the introduction of a new value pack size, said Lissette.

But retailers can shorten that timeline. They can use cheaper private brands, such as peanut butter, cereal and laundry detergent that are similar to well-known national brands.

Kroger last fall launched Smart Way, a new private brand with more than 100 items like bread, canned vegetables and other staples at the lowest prices.

McMullen said the grocer had planned to launch private label, but pushed back its debut by about six to nine months because of shoppers’ interest in value amid inflation. And he added, if national brands lose market share, they’re more likely to be aggressive about discounting — or even permanently reducing their prices.

Zandi, the Moody’s economist, said while customers may be frustrated, they are powerless. By choosing competing brands or choosing items to promote, they can send a message.

“Businesses are responding to shoppers,” he said. “If consumers are price conscious, price sensitive, then they will be able to convince businessmen to stop raising prices and maybe give discounts.”

– CNBC’s Leslie Josephs contributed to this story.