Annual US inflation fell in December to its lowest level in more than a year, in another sign that price pressures may have peaked amid the Federal Reserve’s historic campaign to tighten monetary policy.
The Consumer Price Index, released by the Bureau of Labor Statistics on Thursday, fell for the sixth straight month, posting an annual increase of 6.5 percent.
While still near multi-decade highs, this was the lowest level since October 2021 and marked a significant decrease from the 9.1 percent reached in June. Compared to the previous month, prices decreased by 0.1 percent.
The closely watched “core” gauge, which excludes volatile food and energy prices and is considered the best indicator of the path of inflation, rose 0.3 percent from the previous month, translating to an annual pace of 5.7 percent.
Federal Reserve officials are watching the latest inflation data closely as they decide how much pressure to put on the US economy. Having already stepped back from a half-point rate hike last month – after four consecutive 0.75 percentage point hikes – the central bank is now considering whether it can return to typical quarter-point pacing at its next policy meeting.
Patrick Harker, president of the Philadelphia Fed and voting member of this year’s FOMC, on Thursday endorsed quarter-point increases “going forward,” while Boston Fed’s Suzanne Collins said on Wednesday she leans toward that option.
The odds of a quarter-point rate hike at the February meeting rose to 88 percent on Thursday, compared to 77 percent the day before, according to CME Group.
Government bonds rose after the inflation figures, but pared some of their gains in morning trading. The yield on two-year Treasury notes, which moves with interest rate expectations, fell 0.07 percentage point to 4.16 percent, after earlier hitting a three-month low of 4.11 percent. The S&P 500 index reversed previous declines, rising 0.2 percent in morning trading.
In December, the Fed chose to slow the pace of rate hikes because it had already raised them significantly over a short period of time. It also took into account the time it takes for changes in monetary policy to affect economic activity.
The decision came after a series of better-than-expected inflation data indicated that consumer demand had begun to moderate significantly. This has happened along with the loosening of supply chain knots, which has helped bring down the prices of energy and everyday items such as cars, appliances, and clothing.
December’s drop was attributed to a sharp drop in gasoline prices, which fell 9.4 percent and are now down 1.5 percent over the past year. This more than offset the rise in housing-related costs, with the shelter index rising 0.8 percent. On an annual basis, it was up 7.5 percent.
Economists expect housing inflation to decline significantly later this year, reflecting the sharp decline in home prices and the stabilization of rent increases that have already occurred. Such changes take time to show up in official government statistics, about six to nine months late, according to Michael Bond, head of global inflation research at Barclays.
Clothing, leisure activities and personal care services were among the categories that recorded gains. Prices for used cars and airline tickets have plummeted.
“Higher interest rates are the only thing that will lower shelter costs,” said Alex Feraud, chief investment officer for fixed income at Insight Investments.
The Fed pays close attention to service inflation, once you remove costs related to energy, food and housing, which officials say are closely tied to the labor market and wage gains made as employers seek to cope with severe worker shortages. Wage growth has slowed from its peak, but there are still strong job gains, and the unemployment rate continues to hover around historic lows. Basic services inflation in December rose 0.5 percent, or 7 percent, year on year.
The concern is that price pressures related to services will be difficult to eradicate and require a period of very low growth and high unemployment.
“It is likely that the Fed will need to see weakness in the labor market through a variety of indicators,” Bond said.
Officials have sent a unified message since their December meeting that the federal funds rate probably needs to exceed 5 percent and stay at that level throughout 2023 in order to get inflation under control. It currently ranges between 4.25 percent and 4.5 percent.
This runs counter to current market pricing, which suggests the Fed will raise its policy rate below 5 percent and deliver cuts by the end of the year.
“There are some components of inflation that are still going through in this process,” said Maria Vassallo, co-CEO of Multi-Asset Solutions at Goldman Sachs Asset Management. Inflation is falling – this is not surprising. It’s a matter of how quickly we can get back to the target.”