The Federal Reserve’s favored inflation measure has fallen below 3%, marking the first time since March 2021, prior to the central bank’s campaign of rate hikes. The Personal Consumption Expenditures (PCE) index reported a 2.6% year-over-year increase in December, similar to the previous month’s figure. The “core” PCE, which excludes volatile food and energy categories, rose by 2.9%, down from the previous month’s 3.2% and below the expected 3.0% forecast from economists surveyed by Bloomberg. Core PCE is the widely referenced inflation measure by Fed Chair Jerome Powell. On a month-over-month basis, core PCE increased by 0.2% in December, up from 0.1% in November. Crucially, the annualized core PCE over the past three and six months is now below the Fed’s 2% target.
According to Capital Economics deputy chief US economist Andrew Hunter, “Core PCE inflation has been running at an annualized pace in line with the Fed’s 2% target for seven months now.” This emphasizes the message that there isn’t really any more disinflation left to achieve, and that despite resilient real economic growth, there is ample room for the Fed to commence interest rate cuts soon. The inflation data may heighten expectations for the central bank to start cutting interest rates after two years of increases. During the December Fed press conference, Powell mentioned to Yahoo Finance’s Jennifer Schonberger that the Fed would want to ease economic restrictions well before inflation reaches 2%.
Goldman Sachs chief economist Jan Hatzius stated during an interview with Yahoo Finance Live that “the driver of rate cuts, in my view, is what happens to inflation.” He added, “the disinflationary trend cutting through the monthly ups and downs is still very much intact.” Ahead of Friday’s release, markets had priced in a roughly 50-50 chance of a rate cut in March, according to the CME FedWatch Tool. The Federal Reserve’s next decision on interest rates is scheduled for Wednesday, Jan. 31.
December’s PCE reading aligns with another widely observed inflation measure, the Consumer Price Index for the same month, which also indicated a reduction in core price increases with December’s report showing core inflation at 3.9%. Importantly, both reports have coincided with recent positive signals regarding the economy. Fourth-quarter economic growth surpassed expectations, and data from the S&P Flash PMI revealed that economic output in January reached its highest levels in seven months. This comes as consumer spending remains resilient and the labor market remains strong.
