Inflation Gauge Shows Cooling Rate of Price Increases in December 2023
As 2023 came to a close, an important inflation gauge released by the Commerce Department revealed that the rate of price increases had cooled. The personal consumption expenditures price index for December, which is a crucial measure for the Federal Reserve, showed a 0.2% increase on a monthly basis and a 2.9% increase on a yearly basis, excluding food and energy. Economists had anticipated slightly higher increases of 0.2% and 3%, respectively.
While core inflation increased from 0.1% in November on a monthly basis, the annual rate actually declined from 3.2%. This marks the lowest 12-month rate since March 2021. When including volatile food and energy costs, headline inflation also rose by 0.2% for the month and remained steady at 2.6% annually.
The release of this data adds to the growing evidence that inflation, though still elevated, is gradually making progress lower. This could potentially give the Federal Reserve the green light to start cutting interest rates later in the year. The central bank has set a target of 2% as a healthy annual inflation rate.
Despite this significant development, the markets seemed relatively unfazed by the data. Stock futures indicated only a slight change at the open, and Treasury yields mostly trended lower.
“Inflation dynamics inside the metric that the Fed uses to formulate policy strongly imply that the central bank will hit its inflation target in the near term,” said Joseph Brusuelas, chief economist at RSM. “This will create the conditions in which it makes [its] policy pivot and begins a multiyear campaign in which it reduces the policy rate towards a range between 2.5% and 3%.”
Currently, the Fed’s benchmark overnight interest rate is targeted between 5.25% and 5.5%. As inflation inches closer to the Fed’s target, consumer spending experienced a stronger-than-expected increase of 0.7%, surpassing the estimated 0.5%. However, personal income growth slightly dipped to 0.3%, aligning with the forecast.
The data also revealed that consumers are tapping into their savings to cover their expenses. The personal savings rate fell to 3.7% for the month, down from 4.1% in November.
Analyzing the inflation numbers further, prices for goods declined by 0.2%, while services prices rose by 0.3%. This reversal in trend is attributed to the pandemic, which forced people to stay home more, resulting in increased demand for goods and exacerbating supply chain issues and price hikes. Food prices increased by 0.1% on the month, while energy goods and services rose by 0.3%. Prices for durable goods such as appliances, computers, and vehicles decreased by 0.4%.
When combined with a separate report indicating that gross domestic product grew at a much faster-than-expected pace of 3.3% in the fourth quarter, the most recent round of data suggests an expanding economy and inflation gradually moving back towards the Fed’s 2% annual target.
While the public tends to closely follow the Labor Department’s consumer price index, Fed policymakers prefer the personal consumption expenditures price index because it adjusts for shifts in consumer spending patterns. In contrast, the consumer price index measures prices in the marketplace.
Inflation has been a persistent issue since the early days of the Covid pandemic when price increases reached their highest levels since the early 1980s. Initially, the Fed believed this acceleration would be temporary and responded with a series of interest rate hikes, bringing its benchmark rate to its highest level in over 22 years.
Now, with the inflation rate cooling, market expectations largely point towards the Fed starting to unwind its policy tightening. As of Friday morning, futures traders were assigning a 53% chance that the Fed would enact its first rate cut in March, according to CME Group data. The pricing suggests the possibility of six quarter-percentage point decreases throughout the year.
In conclusion, the recent data on inflation indicates a cooling rate of price increases as 2023 drew to a close. This development may provide the Federal Reserve with the opportunity to begin cutting interest rates later this year. As inflation gradually approaches the Fed’s target, consumer spending has shown strength, while personal income growth has slightly dipped. The markets have responded with minimal changes, and the data suggests an expanding economy and inflation moving closer to the Fed’s desired level.