A key inflation indicator released on Friday showed that the rate of price increases cooled towards the end of 2023.
The Commerce Department’s December personal consumption expenditures price index, a key indicator for the Federal Reserve, rose 0.2% month over month and rose 2.9% year over year, excluding food and energy. Economists surveyed by Dow Jones had expected increases of 0.2% and 3%, respectively.
On a monthly basis, core inflation rose from 0.1% in November. However, the annual rate fell from 3.2%. The 12-month rate is the lowest since March 2021.
Taking into account fluctuating food and energy costs, headline inflation also rose 0.2% over the month and remained stable at 2.6% per year.
The release is further evidence that inflation, while still high, is continuing to fall, potentially giving the Fed the green light to start cutting interest rates later this year. The central bank aims for a healthy annual inflation rate of 2%.
Markets paid little attention to the data as stock futures showed only a slight change at the open and government bond yields were mostly lower.
“The inflation dynamics within the metric the Fed uses to formulate its policy strongly suggests that the central bank will achieve its inflation target in the near term,” said Joseph Brusuelas, chief economist at RSM. “This creates the conditions under which it works [its] “cut the key interest rate towards a range between 2.5% and 3%.”
The Fed’s federal funds rate is currently 5.25% to 5.5%.
As inflation neared the Fed’s target, consumer spending rose 0.7%, stronger than the 0.5% estimate. Personal income growth fell slightly to 0.3%, in line with the forecast.
The data suggests that consumers are turning to savings to cover their expenses. The personal savings rate fell to 3.7% for the month, compared to 4.1% in November.
Looking at inflation figures, prices for goods fell by 0.2% while prices for services rose by 0.3%, marking a reversal as inflation began to rise. As the pandemic forced people to stay at home more, demand for goods increased, causing supply chain problems and exacerbating price increases.
Food prices rose 0.1% month-on-month, while energy goods and services rose 0.3%. Prices of longer-lasting consumer goods such as appliances, computers and vehicles fell 0.4%.
Combined with a separate report on Thursday that showed fourth-quarter gross domestic product grew much faster than expected at 3.3%, the latest data shows the economy is expanding and inflation is at least returning to Fed levels 2% annual target.
“It’s hard to say what’s more remarkable: that GDP growth accelerated last year after the Fed’s most aggressive tightening campaign in decades, or that core inflation still fell back to the 2% annual target in the second half of the year,” wrote Andrew Hunter , deputy chief U.S. economist at Capital Economics.
“In any case, it is time for Fed officials to win the day and start tapering the level of restrictive policy soon,” he added.
While the public follows the Labor Department’s consumer price index more closely, Fed policymakers prefer the PCE because it takes into account changes in actual consumer purchases, while the CPI measures prices in the market.
Inflation has been a vexing problem since the early days of the Covid pandemic, when price increases reached their highest levels since the early 1980s. The Fed initially assumed the acceleration would be temporary, then responded with a series of rate hikes that brought its key interest rate to its highest level in more than 22 years.
With inflation now cooling, markets are largely expecting the Fed to begin unwinding its monetary policy tightening. As of Friday morning, futures traders estimated there was about a 53 percent chance that the Fed will make its first rate cut of the cycle in March, according to data from CME Group. Prices are likely to have fallen by six quarter percentage points this year.
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