Will Gas Prices Foreshadow Higher Inflation Expectations?

April 27, 2023
By Knowledge Leaders Team in Economy, News

Tomorrow, the University of Michigan’s Consumer Sentiment Survey will give us more information on US consumers’ inflation expectations. The survey respondents’ inflation expectations, as other analysts have pointed out, are highly correlated with gasoline prices, which rose in March by 3.7%. This survey, along with Friday’s PCE deflator data will likely be the last data points available going into the Fed’s FOMC meeting on Tuesday and Wednesday next week. Given March’s rise in gasoline prices, it is possible that if this past statistical relationship holds, consumers will once again say they are expecting inflation to be well above 4% a year out, perhaps adding pressure to FOMC members to hike one more time, despite a slew of evidence that the economy is slowing and several other inflation metrics rolling over.

Below is a simple linear regression with prices as observed by the US National Average Daily AAA Gasoline Regular Unleaded price and the median estimate from the University of Michigan’s survey question on the “Expected Change in Prices During the Next Year.” This plot includes monthly data from the last two years.

Gas Prices (X-axis) V. Inflation Expectations (Y-axis):

This regression’s correlation coefficient is 90%, suggesting a strong relationship between changes in gas prices and inflation expectations. This means the r^2 suggests that 80% of the movements in the University of Michigan Consumer Sentiment Survey are due to changes in gas prices. The regression also has a t-stat of 12, indicating that it is very statistically significant (t-stat > 2 indicates statistical significance).

The Fed has indicated that it considers the University of Michigan’s inflation expectations to conduct policy making decisions along with many other macroeconomic variables. Looking at the chart below, on March 17, survey respondents indicated they expected 1-year inflation to be around 3.8%. But then on April 14, the survey ticked up higher, with the current reading of 4.6% for expected inflation. This is the latest reading, and it is right on the “line of best fit” on the regression chart above. While the national gasoline price is down dramatically from the incredible heights of last summer, gas prices are now up over 17% from December 2022 lows.

According to Bloomberg, economists estimate the finalized reading for April to come out at 4.55% tomorrow. Will gasoline prices contribute to higher inflation expectations and lead FOMC members to consider another hike? We’ll see tomorrow.


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