Fed is Looking for Clear Evidence Inflation is Under Control Before Cutting Interest Rates

Inflation stayed stubbornly high in February, with new data showing mixed signals about whether it’s headed up or down in the future. Consumer prices, as measured by Personal Consumption Expenditures, rose 2.5% over the past 12 months as of February, an acceleration from the 2.4% annual inflation of January, mainly because of rising energy prices, the Bureau of Economic Analysis said Friday.

Key Takeaways

• Inflation, as measured by Personal Consumption Expenditures, stayed stubborn in February, confirming a trend shown in a different inflation measure released earlier this month.
• The PCE rose 2.5% over the past 12 months as of February, an acceleration from the 2.4% annual inflation of January, mainly because of rising energy prices.
• However, “core” inflation, which excludes volatile prices for food and energy, rose 2.8% over the year, a deceleration from a 2.9% increase in January and its lowest since March 2021.
• Officials at the Federal Reserve view PCE as a more accurate gauge of inflation than the more widely reported CPI. Fed officials have looked past recent high inflation readings, but further disappointing data could prompt them to delay cuts to interest rates.

Meanwhile, “core” inflation, which excludes volatile prices for food and energy, rose 2.8% over the year, a deceleration from a 2.9% increase in January and its lowest since March 2021. Both measures were in line with forecasters’ expectations, according to a survey of economists by Dow Jones Newswires and the Wall Street Journal.

The report echoed the trends of a separate inflation measure, the widely-watched Consumer Price Index for February, released earlier this month. Both showed inflation making an unwelcome rebound at the start of the year after almost two years of generally falling.

The PCE is especially noteworthy because it’s closely watched by officials at the Federal Reserve who set the central bank’s monetary policy to combat inflation. Higher inflation could spur them to keep the influential fed funds rate, and hence, interest rates on all kinds of other loans, higher for longer than previously expected in an effort to quench rapid price increases.

Despite the uptick in the annual inflation rate—the first increase since September—there were signs that inflation pressures are still on a bumpy path down to the Fed’s goal of a 2% annual rate. Core inflation rose 0.3% in February from January, a decrease from the upwardly-revised 0.5% jump the month before.

Implications for Interest Rates

Stubborn inflation at the outset of the year has left financial market participants wondering if the Fed will follow through on its plans to cut interest rates at some point this year. Earlier data—including the surprisingly hot inflation showing in February’s CPI report, didn’t alter those plans, according to economic projections made at the Fed policy committee’s most recent meeting earlier this month.

Fed officials have said their actions will be guided by data. While February’s data showing stubborn inflation is unlikely to spur them to cut interest rates soon, it also isn’t bad enough to derail expectations for cuts at some point this year if inflation resumes its earlier downward path.

“With the economic backdrop still strong and inflation remaining a little stickier, we are likely to push back the date of the first rate cut from the Fed from May to June,” Michael Pearce, deputy chief U.S. economist at Oxford Economics, wrote in a commentary.

Conclusion

The Federal Reserve is closely monitoring inflation trends before making any decisions regarding interest rates. The recent data showing mixed signals about inflation levels in February has left policymakers cautious about cutting rates too soon. While there are signs that inflation pressures may be easing slightly, further evidence is needed to confirm that inflation is under control before any rate cuts are implemented.

Market participants will be eagerly awaiting upcoming economic data releases to gauge the trajectory of inflation and anticipate potential moves by the Fed. The central bank’s decisions regarding interest rates will have significant implications for various sectors of the economy, making it crucial for policymakers to have a clear understanding of inflation trends before taking any action.

Overall, the Fed’s focus on clear evidence that inflation is under control highlights the importance of data-driven decision-making in monetary policy. As economic conditions continue to evolve, policymakers will need to remain vigilant and responsive to ensure stability and growth in the economy.