Core US Inflation Picks Up, Damping Odds of Outsize Fed Cut

Inflation Remains Elevated

The core personal consumption expenditures (PCE) price index, which excludes volatile food and energy prices, rose 0.6% in January, above economists' expectations of a 0.5% increase. This marked the biggest monthly gain since June 2022 and brought the annual core PCE inflation rate to 4.7%, above the Federal Reserve's 2% target.

The increase was driven by a range of factors, including rising prices for shelter, transportation, and healthcare. Shelter costs, which account for about a third of the core PCE index, rose 0.7% in January, the largest monthly increase since October 2022.

Fed Policy Implications

The higher-than-expected inflation reading dampens expectations for a more aggressive interest rate cut by the Federal Reserve at its next meeting in March. The Fed has been raising interest rates since March 2022 to combat inflation, but it has signaled that it may slow the pace of rate hikes as inflation eases.

However, the latest inflation data suggests that inflation is still well above the Fed's target and may not be cooling as quickly as hoped. This could prompt the Fed to raise interest rates more aggressively than anticipated, potentially weighing on economic growth.

Outlook for Inflation

Economists expect inflation to continue to moderate in the coming months, but it is likely to remain elevated for some time. The ongoing war in Ukraine is continuing to push up energy and food prices, while ongoing supply chain disruptions are also contributing to inflation pressures.

The Fed is expected to continue raising interest rates gradually, but it will closely monitor inflation data and economic conditions to determine the appropriate pace of rate hikes. The central bank is also expected to start reducing its balance sheet, which will help to tighten monetary policy.

Conclusion

The latest inflation data highlights that the Fed's fight against inflation is not yet over. While inflation is easing, it remains elevated and could prompt the Fed to raise interest rates more aggressively than anticipated. This could weigh on economic growth, but it is necessary to bring inflation down to the Fed's target of 2%.