A measure of inflation closely watched by the Federal Reserve continued to ease in December, the latest sign that price increases are coming back under control even as growth remains solid and the labor market healthy. In particularly positive news, a key gauge of price increases fell below 3 percent for the first time since early 2021.
The Personal Consumption Expenditure price index rose 2.6% last month compared to a year earlier. That was in line with what economists had predicted and matched November’s reading.
But after stripping out food and fuel costs, which can move from month to month, a “core” price index rose 2.9 percent from December 2022. That followed a 3.2 percent reading in November and was the coolest since March 2021.
Fed officials are targeting rate increases of 2%, so today’s inflation remains elevated. However, it is well below the peak of around 7% in 2022. In their latest economic forecasts, central bankers predicted that inflation would ease to 2.4% by the end of the year.
With inflation returning to target, policymakers have been able to back off their campaign to slow the economy. Fed officials raised interest rates to a range of 5.25 to 5.5 percent, up sharply from near zero as recently as early 2022. However, they have kept borrowing costs steady at that level since July — giving up a final rate hike they had previously predicted – and have indicated they could cut rates several times this year.
Officials are trying to finish the process of collapsing the economy gently, without causing severe financial pain, in what is often called a “soft landing.”
“The key point here is that the data is still consistent with a relatively soft landing, at least for now,” said Gennadiy Goldberg, chief U.S. interest rate strategist at TD Securities. Between strong growth and softer inflation, they “get the best of both worlds.”
Now, investors are watching closely to see when and how much policymakers will cut borrowing costs.
Fed officials are walking a fine line as they decide what to do next. Keeping interest rates too high for too long could risk cooling the economy more than is absolutely necessary. But reducing them prematurely could allow the economy to overheat, making it harder to fully control inflation.
Fed policymakers meet next week, and officials are expected to leave interest rates unchanged when that meeting ends on Wednesday. However, markets will be closely watching a news conference with Jerome H. Powell, the Fed chairman, for any hint of what may come next.
Mr. Powell can provide insight into how the Fed thinks about the interplay between growth and inflation. The economy is still growing at a steady pace and unemployment is very low, which many economic models suggest could trigger a rebound in inflation.
Friday’s report showed consumption rose more than economists expected in December, for example, especially after adjusting for cooling inflation.
However, so far, price increases have continued to moderate despite the momentum. This has come as the labor market balances out, supply chain issues linked to the pandemic clear up and rent increases fall to more normal levels.
Given that, officials have focused more on actual price numbers in recent months as they talk about the policy outlook. But they still consider growth when thinking about policy.
Rapid growth is “a problem only to the extent that it makes it harder for us to meet our goals,” Mr. Powell said in December. “It will probably put some upward pressure on inflation. That could mean it takes longer to get to 2 percent inflation. That could mean we have to keep interest rates higher for longer.”
