Inflation eased further in January as Fed weighs when to cut rates

The path to getting inflation down has not been steady. On Tuesday, another bump got in the way.

Fresh data from the Bureau of Labor Statistics showed prices rose 3.1 percent in January compared with the year before. That’s a slower increase than the 3.4 percent annual rate notched in December, and leagues below the post-covid peak of 9.1 percent.

But the report came in hotter than analysts expected, narrowly dashing hopes that the annual inflation figure would dip below 3 percent for the first time since early 2021. And as the Federal Reserve fights to wrestle inflation all the way down to a more normal 2 percent, central bankers know success is still just out of reach, potentially slowing the Fed’s march toward the first interest rate cut in years.

“There are still a lot of inflation risks out there, even though we can enjoy the moderation,” said Peter Boockvar, chief investment officer of Bleakley Financial Group. “We’re being reminded that inflation is not this easy path down to 2. I just think this gives extra reason for the Fed to just take their time.”

Markets, impatient for rate cuts, flashed red, with the Dow Jones Industrial Average falling 446.16 points, or 1.15 percent around midday. The S&P 500 index fell 1.17 percent, and the Nasdaq 1.41 percent.

In many ways, though, January’s inflation told a familiar story. As has been the case for months, housing costs continue to make up the lion’s share of America’s inflation, while price increases ebb in other categories such as gas and used cars.

In a statement, President Biden pointed to his moves to lower costs further, often through targeted policies that work differently than interest rates. For example, Biden said he was pushing to reduce prices for prescription drugs and nix junk fees.

“At a time when growth and employment remain strong, inflation declined by two thirds from its peak, but we know there’s still work to do to lower costs,” his statement read.

Fed officials - who have their eyes on multiple interest rate cuts this year - aren’t expected to make any concrete decisions based on the January data alone. Instead, they have been looking for more assurance that inflation is gradually trending down.

Derek Tang, economist and co-founder at the research firm LHMeyer, said that with so much progress in the rearview mirror, the Fed’s main worry isn’t that inflation is going to start heating up again. Instead, the prevailing risk is that inflation stops falling and keeps the Fed from finishing its job.

“Two percent is their target,” Tang said. “And so the strategy here is just to wait a little longer before they start cutting.”

That was the message put forward by Fed Chair Jerome H. Powell at a news conference last month. After six straight months of encouraging inflation news, Powell said officials’ confidence is building that inflation is on a steady downward path. But it’s too soon to declare victory.

“What do we want to see? We want to see more good data,” Powell said. “It’s not that we’re looking for better data. We’re looking at continuation of the good data that we’ve been seeing.”

Financial markets are eager for a definitive timeline. So are many households and businesses, since lower rates filter down to all kinds of investments, like as car payments, mortgages and business loans.

Powell has taken a cut at the Fed’s next meeting in March off the table. Odds seem to be growing for an initial move in May or June, as long as no surprises threaten the economy in the meantime. After Tuesday’s data release, forecasters appeared to lean harder toward a June cut.

For now, policymakers are sticking to the data as it unfolds.

“I don’t want to put timing on it really,” Cleveland Fed President Loretta Mester told reporters earlier this month. “Later this year - if things evolve as anticipated - we would be able to start moving the rate down. I think that would be appropriate. But again, I don’t feel that there’s a sense of urgency here.”

The Fed sprinted to hoist interest rates in 2022 and 2023, and officials say they soon will move to cut borrowing costs multiple times this year. The idea is that even though inflation hasn’t settled all the way down, the economy is stable enough for the Fed to take its foot off the brake. But Tuesday’s report was a reminder that it may take a while for the central bank to feel comfortable with the shift.

Americans’ feelings about the economy have been gradually improving. Consumer sentiment - a helpful glimpse into people’s moods - jumped 13 percent in January to its highest level since mid-2021, according to a closely watched survey by the University of Michigan. The S&P 500 stock index also set a new closing record on Friday, and it has gained more than 5 percent in the first five weeks of the year. That could all be good news for President Biden, as the White House tries to sell its economic record ahead of the November election.

But for the Fed, the inflation fight isn’t over yet. A big reason is housing costs, which have been a driving force keeping inflation high for over a year. Tuesday’s report showed the shelter index - namely rent - accounted for more than two-thirds of the rise in inflation. Rent costs were also up 6.1 percent compared to one year ago.

Real-time data shows that rents on new leases are leveling off, and the construction of tens of thousands of new units should bring more relief to the market. Still, it’s clear that overall inflation - and people’s own budgets - won’t come back into better balance without more progress on the housing front.

Other categories saw increases, too, including car insurance and medical care. A narrower, closely watched measure of inflation that strips out volatile categories such as food and energy rose 3.9 percent over the year before - still higher than normal, but consistent with the kind of progress that Fed officials have seen over the past few months.

Meanwhile, costs for used cars and trucks, clothing and gas fell the most.

The January figures show remarkable progress since inflation soared to 40-year highs. Gas costs have fallen significantly since Russia’s invasion of Ukraine triggered a global energy crisis. Supply chains have cleared their backlogs, taming prices for refrigerators and rugs alike. And the labor market has kept growing, albeit at a more sustainable pace, helping cool the kind of blockbuster wage growth that can make inflation even worse.

Trying to quash price increases, the Fed has pushed interest rates to the highest level in more than two decades. Those aggressive moves were widely expected to yank the economy into a recession. But instead, employers have kept hiring, and consumers are still spending on everyday items and big-ticket purchases. All told, the economy continues to grow in ways that look more and more like a “soft landing” - an end to inflation without a painful economic contraction.