In the first deflationary reading since the early days of the Covid-19 pandemic, the headline consumer price index fell 0.1% in December on a monthly basis, the Bureau of Labor Statistics said Thursday, providing fresh hope that inflation is coming under control and could give the Federal Reserve reason to ease its campaign of interest rate hikes.
The annual inflation rate dropped for the sixth month in a row, falling from 7.1% in November to 6.5% last month, its lowest level in the last year. The core price index, which leaves out volatile food and fuel prices, also slowed, rising 5.7% on an annual basis, down from 6% in November. On a monthly basis, however, the core inflation rate rose 0.3%, slightly higher than the 0.2% rate recorded a month earlier.
The three-month average of core prices rose by just 3.1%, suggesting that the pullback in inflation is accelerating.
Big declines in the prices of televisions (down 14.4% on an annual basis), used cars (down 8.8%) and computers (down 5.8%) played a role in the overall results. Gasoline fell, too, down 2% relative to a year ago and 9.4% on a monthly basis. But price increases persisted in some sectors, including the prices of eggs (up 59.9% over the last year), heating fuel (up 41.5%) and air travel (up 28.5%).
Growing optimism: Although the annual inflation rate is still well above the Federal Reserve’s target of 2%, the December consumer price report provides more evidence that upward pressure on prices has passed its peak. "This month's report provides confirmation that the downshift in inflation pressures is becoming entrenched," Morgan Stanley analysts said in a note to clients.
While acknowledging that the outlook for prices still includes some problem areas – most notably the ongoing increase in the cost of shelter – Bloomberg’s Jonathan Levin wrote that “there can be no question that the overall inflation picture looks bright,” adding that “it’s the third report in as many months that supported that conclusion, which means it’s probably not a fluke.”
Saying “the data is clear,” President Joe Biden celebrated the report, attributing the positive developments to the policies enacted by his administration. “Even though inflation is high in major economies around the world, it is coming down in America month after month, giving families some real breathing room,” he said.
Will the Fed ease up? The Fed now faces the question of just how far it will go in its effort to clamp down on the economy. Wall Street wants the central bank to start easing its campaign as quickly as possible, and rising stock values and falling Treasury rates — the yield on the 10-year fell to 3.4% after the report was released Thursday — show that investors are betting that the Fed will pivot sooner rather than later, with a possible rate cut later in the year.
Many analysts now think that the Fed will raise its key rate by just 25 basis points at its next meeting and may stop short of hitting 5% on its benchmark rate. Some are even calling for the Fed to stop raising rates altogether, for fear of pushing a slowing economy into an unnecessary recession. “Put the sledgehammer away, Jay,” Pantheon Economics’ Ian Shepherdson tweeted Thursday, referring to Fed chief Jay Powell.
But Fed officials are warning that the war against inflation is far from over. Inflation is still well above their target, and there’s no guarantee that the recent downward trend will endure. Depending on the data, the Fed could keep pushing rates higher, albeit in smaller increments. And whether or not the Fed gets to a 5% “terminal rate,” bank officials have made it clear that they expect to hold rates at a high level until they are satisfied they have crushed the inflationary surge.
Minneapolis Fed President Neel Kashkari recently told The New York Times that although Wall Street is “culturally, institutionally, optimistic,” no one should doubt the central bank’s dedication to its mission of killing inflation, even if it causes pain for workers and investors. “They are going to lose the game of chicken, I can tell you that,” Kashkari said of those betting that the Fed would soon change its course.
