The Era of Big Price Hikes Is Over, Giving Comfort to the Fed

Hobby Works President Michael Brey knows his customers are fed up with price increases, so he’s stocking up on less costly products he thinks people will actually go for. At his stores in Rockville and Laurel, Maryland, the pandemic-era days of passing on price hikes for items like train sets, remote-controlled cars and drones are over.

“We can’t raise our prices because consumers have kind of maxed out,” Brey said. “We are doubling down on these newer, smaller, entry-level items because they’re at a price point that we think will work for consumers in the current environment.”

Across the US, businesses like Brey’s are reporting a growing constraint on their ability to increase prices. Diminished pricing power should help slow inflation, which has already cooled substantially from the peaks registered two years ago. That could help give Federal Reserve officials comfort to continue cutting interest rates even when incoming inflation data, like the most recent report on consumer prices, is bumpy.

“That it is harder for businesses to pass on prices is an indication that the Fed’s tighter policy stance has been working in reducing inflation,” said Sarah House, senior economist at Wells Fargo. “This will be an important element for them to keep an eye on as they’re trying to finish that last mile of the inflation fight.”

After opting for an outsize half-point interest-rate cut to kick off their easing cycle in September, Fed officials received hotter-than-expected monthly inflation numbers. That and an acceleration in hiring in the latest monthly jobs report have led to some speculation that the US central bank could consider pausing rate cuts at coming meetings.

Policymakers have mostly downplayed such prospects, in part by citing what they’re hearing from business contacts about the outlook. Fed Governor Christopher Waller, speaking on Oct. 14 a few days after the latest report on consumer prices, called the numbers “disappointing.” But he added that reports from firms about waning pricing power are among the reasons he expects “increases will be modest going forward.”

Richmond Fed President Thomas Barkin and his San Francisco counterpart, Mary Daly, both made similar comments following the inflation report, citing anecdotes of increasingly cost-conscious consumers doing things like buying private-label products instead of branded ones.

“You see a lot more promotions. You see a lot more price reductions. You see a lot more channel-shifting, and that’s what’s bringing inflation down,” Barkin said at an Oct. 10 event. “That’s how it’s supposed to work, which is that high prices eventually fix high prices because people make other choices.”

As the economy reopened following the onset of the Covid-19 pandemic, businesses hiked prices as they faced strong consumer demand, widespread supply-chain disruptions and a generational opportunity to charge more. This year, however, the tide has turned.

Some $2.1 trillion in extra savings Americans accumulated between the pandemic’s onset and August 2021 were fully spent by March 2024, according to San Francisco Fed research. Meanwhile New York Fed data show a steady rise in the number of Americans behind on credit-card payments. And wage growth has cooled amid a slowdown in hiring, leaving shoppers choosier about what they buy and how much they pay for it.

In September, a net 25 percent of small businesses said they were planning to raise prices in the next three months, according to a National Federation of Independent Business survey. That puts the measure back in its pre-pandemic range after rising as high as 54 percent in late 2021.

Corporate earnings calls tell a similar story. Dirk Van de Put, chief executive officer of Oreo-maker Mondelez International, told analysts in September that while the company will raise some prices, it will do so “in steps so that we can see how the consumer reaction is” while “putting in place very close follow-up mechanisms.”

Narrowing profit margins also point to waning pricing power, according to Wells Fargo’s House. While economy-wide margins remain well above pre-pandemic levels, they’ve come down substantially in the retail and wholesale trade sectors after surging in 2021 and 2022.

At Hobby Works, Brey said customers in recent years were willing to take price increases “on the chin.” But now, they won’t pay more than what they perceive to be a reasonable price, causing sales declines in some of the stores’ departments. He’s managing that by stocking up on more affordable products, like a small remote-controlled car in the $150 to $200 range.

Some important indicators point to ongoing consumer resilience. Retail sales bested expectations in September, putting economic growth on track for its strongest quarter in a year, according to an Atlanta Fed model.

Fun Stuff

But persistent price increases for essentials like shelter, health care and insurance are limiting how much businesses can charge for discretionary categories, House said.

“We’re still looking at a pretty healthy consumer,” she said. “But right now, just given the inflation we’ve seen in those non-discretionary items, that’s leaving less money left over to go spend on the fun stuff.”

Results of a periodic Fed survey of regional business contacts published Wednesday showed businesses across the country are seeing rising price sensitivity among their customers.

In the Atlanta district, for example, “contacts reported a continued trend of declining discretionary spending and trading down to lower-priced goods and services,” the report said. “Though this was still mostly concentrated among lower-income groups, middle- to high-income consumers, while continuing to spend, became more selective with purchases and sought discounts.”

Ernest Lee, chief commercial officer at citizenM, a hotel chain with locations in several large US cities, said pricing power with leisure travellers has been challenged this year. He attributes that to consumers spending down cash they saved during the pandemic and the crunch high borrowing costs have put on household budgets. He said a decline in booking lead times this year is one sign of the emerging trend.

“The consumer feels that there will be enough inventory to purchase later or closer to their trip” and they can “still get within their budget,” Lee said.

By Amara Omeokwe