Rising inflation will slow down the ongoing U.S. consumer spending recovery in 2022, according to economists.

Consumer spending is a key pillar of the U.S. economy, accounting for 68% of GDP. Personal consumption expenditure grew 7.9% in 2021, rebounding from pandemic lows. Economists anticipate spending growth to continue in 2022, but at a slower pace than in 2021. Oxford Economics forecasts 2022 consumption will grow 3.5%, while Wells Fargo expects spending to increase 2.8% this year.

"With higher-income households able to rely on their excess savings and strong wage growth acting as a buffer against rising prices for lower-income earners, consumer spending should remain robust this year," Lydia Boussour, lead U.S. economist at Oxford Economics, said in an email.

Wage rises among low-income families and wealthier families' high savings rates are supporting the growth of American consumption. Low-income earners have enjoyed the biggest increase in wages during the recovery, with a 5.8% year-over-year increase for workers in the lowest 25% wage bracket, as opposed to 2.9% for top earners. Higher earners also drove up the U.S. personal savings rate from a pre-pandemic rate of less than 8% to peaks of 33.8% in April 2020 and 26.6% in March 2021.

At the same time, the fastest inflation in 40 years — 6.1% year over year in January for the personal consumption expenditures price index — is taking a toll on consumers' purchasing power.

Shannon Seery, an economist at Wells Fargo, noted the crunch consumers are feeling. "A lack of fiscal stimulus and higher prices are weighing on real disposable personal income and leaving consumers with tough choices in terms of purchasing power," Seery said in an email.

Not everyone is convinced though. Fiscal transfers that boosted consumption are fading, with support for low-income families from measures such as the increase in child tax credits — introduced in the March 2021 American Rescue Plan Act — being allowed to lapse.

"We are relatively pessimistic about the prospects for real consumption," said Paul Ashworth, chief North America economist at Capital Economics. "Continued employment growth and strong wage growth will boost nominal incomes, but government transfers are falling as pandemic-era fiscal stimulus expires."

Retail sales growth

Recent data has been mixed. The Conference Board's consumer confidence index fell for the second-consecutive month in February and remains far below the pre-pandemic level. The survey found that expectations for short-term growth weakened, while concerns over inflation rose.

Yet retail sales rebounded in January, growing by 3.8%, the strongest monthly gain since March 2021 when stimulus checks were arriving in the post. Core sales — excluding autos, gasoline, and building materials — were even better, rising by 4.8% in January.

"The low level of consumer confidence is another negative signal. But I wouldn’t oversell that; the relationship between confidence and spending hasn't been that strong for quite a while now," Ashworth said.

The uptick in January activity was bolstered by a 14.5% increase in online sales as the rapid spread of omicron pushed shoppers onto their computers. Sales at restaurants and bars suffered as a result, declining by 0.9%.

Diminishing omicron factor

The good news for providers of such services is that the omicron wave may be over.

The number of new cases has plummeted. The rolling seven-day average is down from over 800,000 in mid-January to less than 63,000 on Feb. 27, according to the Centers for Disease Control and Prevention, while average daily deaths are down from over 2,600 in early February to 1,686.

"With the omicron surge now in the rearview mirror, we expect to see a further rebalancing of consumer spending away from goods and towards services in the coming months," Boussour said.

The restrictions on restaurants, bars and other service providers have concentrated spending on goods, driving up demand and exacerbating the supply issues hamstringing many sectors.

"Moderating demand, along with a slow easing of supply chain issues, should take some of the pressure off goods prices later this year," Boussour said, though she still expects inflation to remain elevated at above 3% at the end of the year.

Inflation problem

Inflation is the main headwind for consumption, not just through the reduction in purchasing power. It also poses a psychological barrier to spending even as rising wages go some way to offsetting the rise in prices.

"For more than half the country, this is the highest inflation they have seen in their lifetime, and that is having a predictable effect on consumer psyche," Seery said.

Price hikes are also showing no signs of letting up, Boussour said.

"It is weighing on consumers' morale and dampening their ability to spend, especially for low-income families," Boussour said.