Inflation Rises to 2.8%, Posing Challenges for Federal Reserve’s Rate Cut Plans
The Federal Reserve’s efforts to bring inflation back to its target of 2% have hit a roadblock, as the latest data shows a rise in inflation. The core personal consumption expenditures (PCE) price index, which is the central bank’s preferred measure of inflation, increased by 0.4% last month and 2.8% from a year ago, according to the Bureau of Economic Analysis.
This news comes as a blow to Fed officials who were hoping to start cutting interest rates, as inflation had been steadily declining from its peak of 9.1% in 2022. While the core PCE price index aligns with Wall Street’s expectations, economists argue that the 2.8% figure is not sufficient for Fed Chair Jerome Powell and his colleagues to feel comfortable with rate cuts this spring. The core PCE price index excludes food and energy prices, which are known for their volatility.
David Alcaly, lead macroeconomic strategist at Lazard Asset Management, explains that this “hot” inflation data adds uncertainty and delays rate cut expectations. However, he believes that overall, Thursday’s inflation report is just a “speed bump” in the Fed’s mission to control inflation.
On the other hand, Citi economists led by Andrew Hollenhorst warn that the chances of a recession have increased following the latest inflation report. Hollenhorst predicts that the Fed will not be able to cut rates until June and argues that there is little hope for disinflation at the moment due to a strong labor market and resilient consumer spending. He adds that higher inflation and policy rates today raise the likelihood of a recession later this year.
In contrast, Paul Ashworth, chief North America economist at Capital Economics, agrees with Alcaly’s perspective. He describes the resurgence in core inflation as a “speed bump” rather than a major obstacle. Ashworth believes that the latest inflation report rules out an early interest rate cut from the Fed this year. However, he points out that there is still a significant amount of disinflation expected throughout the year, which should bring the annual rate of core PCE inflation close to the 2% target by midyear.
The decline in personal spending in January further supports the argument that consumers are pulling back on spending, which could help with inflation. Personal spending, which drives 70% of U.S. GDP growth, fell by 0.1% after a surge of 0.6% in December. The decrease in spending on goods, which can be partly attributed to bad weather, indicates a potential slowdown in overall consumer spending.
Additionally, real disposable income, a measure of consumers’ income after expenses and adjusted for inflation, also fell by 0.1% in January. Jeffrey Roach, LPL Financial’s chief economist, suggests that investors should closely monitor this decline as it may indicate that consumers are nearing the end of their spending spree.
For Roach and many other economists, the latest inflation report is not a cause for panic but rather a sign that the Fed needs to remain patient in its efforts to control inflation. He maintains that the narrative remains unchanged, with the next move by the Fed likely to be a rate cut.
Overall, the latest inflation report presents challenges for the Federal Reserve’s rate cut plans. While some economists argue that the rise in inflation is just a temporary setback, others warn of potential recession risks. As the Fed navigates these challenges, it is clear that patience will be key in achieving its inflation targets.