The Federal Reserve moved one step closer to potentially easing its aggressive interest rate hiking campaign, as new data on Friday showed inflation continuing to drift back towards the central bank’s 2% target.
The Commerce Department’s personal consumption expenditures (PCE) price index, the Fed’s preferred inflation gauge, rose just 0.2% in December from the prior month and 2.6% from a year earlier, matching November’s rise.
More importantly, the core PCE index, which strips out volatile food and energy costs, increased 0.2% month-over-month and 2.9% year-over-year – the lowest 12-month rise since March 2021.
“The moderation in inflation will likely give the Fed confidence that their tightening campaign is working and that they can start taking their foot off the brakes later this year,” said economist Jane Smith of ABC Capital.
Federal Reserve Approaching Inflection Point on Rates
The data keeps the Fed on track to transition from aggressive rate hikes to potential cuts in 2023 to support economic growth, analysts say. Markets are currently pricing in a near 50% probability of a rate cut at the March policy meeting.
“The PCE report is a tentative green light for the Fed to start easing policy if current inflation trends continue, but risks remain that could delay rate cuts,” explained Michael Jones, senior economist at XYZ Research.
Fed Chair Jerome Powell has signaled rates could start coming down in the second half of 2023 if inflation heads sustainably back to 2%. However, some Fed officials have pushed back on expectations for cuts as early as March.
“The strength of recent economic data argues against premature policy loosening by the Fed. But steady disinflationary trends reinforce the case for rate cuts later this year,” said Jones.
Consumers Remain Resilient Despite Rate Hikes
Importantly, underlying economic momentum remains solid, with consumer spending jumping 0.7% in December, powered by strong wage gains.
The labor market also continues to hold up well despite the Fed’s efforts to cool demand, indicating consumers and businesses have adjusted to higher rates.
Analysts say the resilience of the economy means the Fed can take a patient approach in shifting to an easier policy stance. A premature pivot could risk reigniting inflation.
“The Fed is nearing its inflection point on rates, but should avoid rushing into cuts until inflation is clearly headed back to target,” said Smith.
Overall, the December PCE report likely reinforced the Fed’s expectations that it can start cutting rates in 2023 amid steady disinflation. But uncertainty remains around the exact timing, which will depend on the path of inflation and economic growth in coming months.
