Latest US Inflation Report to Keep Fed Leaning Toward More Rate Hikes

US Inflation Report to Keep Fed Leaning Toward More Rate Hikes

The latest US inflation figures for January released on Tuesday came in line with economists' expectations and signaled pricing pressures are continuing to ease gradually. The report points to inflation remaining stubbornly high which will likely keep the Federal Reserve on its path of further interest rate increases.

The consumer price index (CPI) rose 6.4% in January from a year earlier, down from 6.5% in December, according to the Labor Department. On a monthly basis, CPI rose 0.5% after gaining just 0.1% in December.

Inflation Report

While the annual inflation pace is slowing, it remains well above the Fed's 2% target. The CPI report contained few signs of any imminent collapse in inflation that would allow the central bank to dramatically change course on monetary tightening.

Details of the January Inflation Data

Some details within the CPI inflation report for January include:

• Monthly CPI rose 0.5% against the 0.4% Dow Jones estimate, signaling inflationary pressures are sticky.
• The 12-month core CPI, which excludes food and energy costs, rose 5.6% in January, easing slightly from 5.7% in December. This core figure comes closest to the Fed's preferred inflation gauge.
• Energy prices declined 2.7% in January but are still up 8.7% over the last 12 months. Gasoline prices fell 2.4% for the month.
• Food costs were flat in January after gaining 0.2% in December. The food-at-home index rose 0.4% month-over-month.
• New vehicle prices declined 0.1% but are still higher year-over-year. Used vehicle prices dropped 1.9% last month.

Gradual Disinflation Trend Overall

The latest CPI figure marks the seventh consecutive month that annual inflation has eased after peaking at 9.1% in June 2022. It is also the lowest 12-month increase since October 2021.

This downward trajectory aligns with the Fed's outlook that monetary policy tightening will steadily help reduce price pressures, though it will take time.

The central bank expects headline inflation to fall to 3.5% by end of 2023. But the road to 2% inflation will be long and potentially bumpy until demand-supply imbalances normalize across sectors.

Areas of Sticky Inflation in the Economy

Despite the improving inflation trend, several categories point to pockets of persistent pricing power:

• Services inflation - Prices for services minus energy rose 0.6% in January, the most since July. Services inflation tends to be stickier especially in areas like rents.
• Wage growth - Average hourly earnings are up 4.4% over the past year, so worker pay is still rising faster than inflation. This wage-price spiral dynamic continues feeding into inflation.
• Core goods inflation - Prices rose 0.6% for core goods minus food and energy, following a 0.2% increase in December. This challenges hopes of goods disinflation.

Services make up two-thirds of the CPI basket so stubborn inflation there along with rising wages poses an obstacle for the Fed. Goods disinflation is needed to make serious inflation progress.

Markets Expect Fed to Raise Rate by 0.25 Percentage Point

Based on the largely in-line inflation data, traders continued to bet that the Fed will raise its benchmark interest rate by 25 basis points at the March policy meeting. This would take the fed funds rate range to between 5% and 5.25%.

Financial markets are currently not pricing in the possibility of a larger 50 basis point hike, though Fed policymakers have said they remain data dependent.

The CPI report was not weak enough to alter the Fed’s hiking path, though the smaller 0.25 percentage point increases do show tightening is entering its final stage before rates peak.

Fed's Priority Remains Bringing Down Inflation

Comments from Fed officials leading up to the CPI data signaled their priority remains firm on bringing inflation back down to target. They reiterated that interest rates need to rise further and policy must remain restrictive for some time.

While the central bank shifted to slower rate hikes, it is still focused on controlling inflation expectations. Fed Chair Jerome Powell has stated publicly that disinflation has only "just begun" and is expected to be a long process.

The Fed’s benchmark rate is currently between 4.5% and 4.75% after starting 2022 near zero. Officials anticipate taking rates above 5% and holding them there for an extended period to get the desired cooling effect.

Other Key Data Ahead

Markets are also looking ahead to other inflation-related data on the horizon that will provide additional signals on the state of price pressures:

• Producer price index (PPI) for January due on Wednesday. It is seen easing to 6.2% year-over-year.
• Retail sales figures on Wednesday will show how consumers are reacting to stubborn inflation.
• Regional manufacturing surveys due this week. Any signs of softening output prices will be tracked.
• Minutes from the latest Fed meeting will provide added color on rate hike plans.

Inflation metrics including wages and producer prices remain key guides for Fed policy in coming months as it tries to achieve a controlled 'soft landing'.

Conclusion

While January's CPI inflation moderated slightly, it remains too high for the Fed to declare victory in its battle against price pressures. Underlying inflation trends point to a long road ahead to revert back to the 2% target.

This means the central bank will likely stick to its plan of further rate increases in coming months, moderating only the pace of hikes as it gets closer to peak rates. The latest data is not enough for the Fed to abruptly change course on monetary tightening until inflation is convincingly tamed.

Markets face weeks of uncertainty on exactly how much more the Fed will need to raise rates before it can pause and eventually cut again when inflation normalizes. The path to a 'soft landing' for the economy remains tricky to navigate.

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