Since 2012, the Fed has been aiming at a steady inflation rate of 2 percent year-over-year, adjusting its policy to an average of 2 percent over time in 2020. While U.S. inflation dropped to three percent in June, the smallest increase since March 2021, consumer prices are still higher than the inflation target. Combined with a tight labor market with fewer new jobs and persistent wage growth, this will most likely lead the Fed to raise interest rates after skipping a hike in June. As our chart based on OECD data shows, the U.S. still fared well when compared to the rest of the G7 countries in May.
For example, the United Kingdom's inflation rate reached 7.9 percent at the end of May. It is also the only G7 member where the year-over-year inflation rate rose compared to the previous month. Comparatively high food and energy prices are the main reasons for this increase, but even when excluding these two especially volatile segments, inflation sat at 6.5 percent, considerably higher than in Germany, the United States and Italy, as well as above the G7 total.
While Italy was in a similar bind as the United Kingdom and high food prices drove up inflation in Germany and France, the price hikes connected to the energy crisis fueled by Russia invading Ukraine in February 2022 seem to have largely have scaled back. In the U.S., Canada and Japan, energy prices have dropped between 8 and 12 percent year-over-year.
While the G7 once encompassed the world's leading economies, two important countries, namely China and India, are absent from the group due to their developing status at the time of the founding of the intergovernmental political forum in 1976. According to government data, inflation in India fell to a 25-month low of 4.2 percent in May.
China is on the path toward deflation, with inflation rates at 0.2 percent in May and likely hitting zero percent in June. The producer price index dropped by 4.6 percent as well, the steepest year-on-year drop in seven years. Combined, the development of these indices hints at softening demand and the economy struggling to bounce back from the People's Republic's Zero Covid policy.
