Cooling US inflation argues for slower Fed rate hikes in September

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Shoppers wear masks while shopping at a Walmart store, in North Brunswick, New Jersey, U.S., July 20, 2020. REUTERS/Eduardo Munoz

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May 27 (Reuters) – Evidence that U.S. inflation is cooling will not move Federal Reserve policymakers from the half-point interest rate hikes scheduled for upcoming meetings in June and July, but could prompting a move to lower rate hikes in September if the trend continues.

A US Commerce Department report released on Friday showed that the Personal Consumption Expenditure (PCE) price index rose 6.3% in April from a year earlier. Read more

That’s still more than three times the Fed’s 2% target.

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While prices continue to rise, the pace of the rise has slowed compared to the previous month. April’s PCE reading marked the first deceleration in the measure since November 2020.

The core PCE index, which excludes food and energy prices to give a clearer reading of more lingering price pressures, rose 4.9% – again, far too high for comfort , but marking a second consecutive month of moderation from what could have been a February peak of 5.3%.

The drop in core inflation is particularly good news for the central bank, as well as further evidence that household spending continues to grow despite still rising prices. Friday’s report showed consumer spending rose 0.9% last month.

“While inflation levels in the 4% range are still too high for the Fed, we are seeing movement in the right direction,” National Economist Dan Hadden wrote in a note. As long as inflation continues to stabilize or moderate, “that will likely give the (Fed) more flexibility later this year.”

The Fed has raised interest rates by three-quarters of a percentage point so far this year, and most policymakers expect to offer a few more rate hikes of half a percentage point, public comments recent events and a report of their May meeting.

This would bring overnight interbank borrowing costs to a range of 1.75% to 2% by the end of July. Anticipation of these rate hikes already seems to be weighing on demand in the housing market, where prices have soared, but sharp increases in mortgage rates have helped to lower home sales for a sixth consecutive month in april.

This slowdown suggests that price increases will also moderate in the coming months and, according to Comerica’s Bill Adams, will start showing up in slower inflation readings later this year or early 2023.

Already at the Fed’s May meeting, “a number” of policymakers thought that “monthly data might suggest that overall price pressures may not be worsening further.”

The Fed’s great hope is to get through this era of price shocks and uncertainty with, at worst, a slowdown in the pace of growth, rather than a full recession that causes unemployment to rise dramatically.

“Amid growing pessimism about the state of the U.S. consumer, today’s report provides reassurance that the mainstay of the economy is still strong in the face of historic inflation and rising costs. borrowing,” Lydia Boussour of Oxford Economics wrote on Friday.

U.S. stock markets, which have fallen rapidly in recent weeks as investors took stock of how the Fed’s monetary shift could slow the economy, rose on Friday after inflation data and hope the The Fed’s quest for a “soft landing” may still be within reach.

Traders of Fed key rate futures continued to bet that the central bank will switch to quarter-point rate hikes in September.

For that to happen, the rest of the world will have to cooperate.

The impact of the war in Ukraine on global commodity prices and the ongoing coronavirus lockdowns in China are two major risks that are entirely beyond the Fed’s control.

Fed policymakers also say they are watching inflation expectations closely for signs that the current high inflation is taking root in the psychology of US households and businesses. Recent data suggests that these risks are not getting worse either.

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Fed staff, meanwhile, continues to see headline PCE inflation moderate to 4.3% by year-end and 2.5% by year-end. Next, as a “historically significant” tightening of financial conditions has been felt across the economy, Fed meeting minutes this week showed.

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Reporting by Ann Saphir in Berkeley, California, Howard Schneider in Washington and Lindsay Dunsmuir in Scotland Editing by Matthew Lewis

Our standards: The Thomson Reuters Trust Principles.

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