Inflation is still high. Used car prices could help explain what happens next

Surging prices for used cars were a major driver of inflation earlier this year. Now, there are signs those price hikes may be shifting into reverse – and that could provide important clues about where inflation is headed next.

The prices dealers pay for used cars at massive auctions across the country finally dipped in June after hitting record highs in each of the four previous months, according to the Manheim Used Vehicle Value Index.

Those falls in wholesale prices bodes well for those in the market for a used Jeep. While retail prices at used car lots are still climbing, they will likely start to fall soon.

It also bodes well for the Federal Reserve

The Fed has consistently argued that the recent surge in consumer prices is likely to fade, as pandemic bottlenecks are resolved and demand returns to more normal levels.

It's a view that's shared by many economists, though not all.

"Overall, headline inflation won't accelerate any more and is likely to moderate somewhat over the course of the next six months," says Gregory Daco of Oxford Economics.

Consumer prices spiked 5 percent in May, the highest annual increase in nearly 13 years. Much of that increase was driven by factors that are expected to be short-lived.

Used cars, for example, have been in high demand this year, partly because of a shortage of new cars.

A severe global shortage of semiconductors hit automakers hard, forcing them to limit production despite surging demand.

That supply chain disruption has been magnified by the lingering impact of a deep freeze in Texas earlier this year that limited production of plastics used in cars, as well as by recent flooding in Michigan.

"It's just been a series of perfect storm events that have prevented the new vehicle production from getting back to normal," says Jonathan Smoke, who tracks car prices as chief economist for Cox Automotive. "And while that supply has been challenged, we've had surging demand" for cars, as more people are driving for work and vacation.

The reduced selection of new cars has had a big spillover in the used market.

The retail price of used cars jumped more than 7 percent between April and May, accounting for about a third of overall inflation that month. That was on top of a 10 percent jump in used car prices the previous month.

Since then, however, the buying frenzy has slowed. Inventory at used car lots has returned to more normal levels, and demand at wholesale auto auctions is less intense than it was earlier this year.

"It isn't that demand has completely cratered," Smoke said. "It is simply that we've gotten past what has been a crazy spring."

Wholesale prices for used cars have dropped more than 2 percent over the last four weeks. Smoke expects by the end of the year, wholesale prices will have fallen 9 percent from their June peak.

Assuming retail prices follow a similar path, that would support the Fed's argument that higher inflation is being driven by temporary phenomenon like used car prices.

"This is the poster child illustration for transitory" price hikes, Smoke says.

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