Cooler Inflation Keeps Door Open for Rate Cuts This Year

The U.S. economy notched another month of mild inflation in December, keeping the Federal Reserve on track to deliberate when and how quickly to reduce interest rates later this year.

The Fed’s preferred inflation measure, the personal-consumption expenditures price index, rose 2.6% in December from a year earlier, the Commerce Department said Friday, well below the 5.4% increase at the end of 2022.

Core prices, which exclude volatile food and energy costs, rose 2.9% on the year, the smallest year-over-year increase since March 2021. Using three- and six-month annualized rates, core inflation was 1.5% and 1.9%, respectively, in December.

“It really is amazing that these three- and six-month inflation rates are below 2%,” said Charles Evans, who was president of the Chicago Fed from 2007 until early 2023. “Six months is a pretty good amount of time” to provide confidence that inflation has sustainably returned to the lower rates seen before the pandemic, he said.

Investors expect the Fed will cut rates this spring in part because inflation has declined much faster than the central bank anticipated. Evans said investors were correct to have that view even though some Fed officials have said they are worried about cutting rates only to have to turn around and raise them again if inflation reaccelerates.

“It’s natural for them to be nervous. They’ve worked really hard. They wouldn’t want to lose sight of 2% inflation at the last minute,” Evans said. “But at some point, you need to recognize that core inflation really has come down.”

Policy statement could change

Fed officials are on track to hold interest rates steady at their two-day policy meeting next week and could remove from their policy statement language that has said their next interest-rate change is more likely to be an increase than a cut.

Core price readings in six of the last seven months have been running at an annualized monthly rate equal to or below the Fed’s 2% target. If that progress continues in the coming months, 12-month inflation rates would be closing in on the Fed’s goal by the time officials meet at the end of April.

The path of inflation over the last six months is showing “sustained progress to the 2% benchmark,” said Lael Brainard, a top economic adviser to President Biden who was previously at the Fed, in a briefing with reporters Friday. “That’s exactly the kind of pattern that would give us confidence that inflation is actually getting anchored back at 2%.”

Normally, the Fed only cuts interest rates because of concerns the economy is slowing more sharply, but officials have said they would consider cutting rates this year if inflation is convincingly falling to their target. That is partly because they are concerned that holding rates steady as inflation declines will lead inflation-adjusted rates to rise to levels that unnecessarily restrain economic activity.

Officials last raised rates in July, when they lifted their benchmark rate to a range between 5.25% and 5.5%, a more than two-decade high. Fed officials penciled in three rate cuts this year in projections at their last meeting in December.

“Everything is now pointing to inflation heading back to 2% and it’s harder to see why they need to keep rates at 5.5%, which officials acknowledge is restrictive territory,”  said Andrew Hunter, an economist at Capital Economics.

Robust consumers

Friday’s Commerce report also showed Americans’ spending rose 0.7% in December from November, after an upwardly revised 0.4% gain the prior month. Consumers spent strongly on services like healthcare and insurance as well as on vehicles and gifts like jewelry and watches. Consumer outlays make up the lion’s share of U.S. economic activity and Friday’s report suggested demand remained strong headed into 2024.

Incomes, however, rose a slower 0.3% last month after a 0.4% November gain.

December was a strong month for Besa, a restaurant in Detroit, with sales up roughly 10% from a year earlier thanks to holiday and corporate events, said managing partner Gerti Begaj. Guests are also increasingly willing to spend more, he said.

“The sense that I’m getting is that people are ready to pay for value,” he said. “Prior to Covid there were times where guests were price-shopping a bit more; now attention is toward value.”

American Express got a boost last quarter from cardholders’ appetite for spending on restaurants, Chief Financial Officer Christophe Le Caillec said in an interview. Across all spending, Le Caillec said growth is normalizing after last year’s big bump from the postpandemic travel boom. He said the company expects spending to be roughly in line with the growth seen in 2023.

Visa said Thursday that profit climbed in its fiscal first quarter, citing resilient consumer spending.

Consumers headed into 2024 on a strong footing thanks to a healthy labor market, cooling inflation and steady wage gains. Those factors helped the U.S. economy defy most economists’ expectations for a recession last year.

Forecasters expect the economy will continue to grow in 2024, albeit at a slower pace, according to a recent Wall Street Journal survey.

“It probably gets a little more challenging for consumer spending as we get deeper into 2024, but so far that momentum for consumers continues,” said Eric Freedman, chief investment officer for U.S. Bank’s Asset Management Group. Higher interest rates for consumers are like a ramp on a treadmill, and over time the ramp means they “start to atrophy, they slow down,” he said.

Higher rates from the Fed’s campaign to curb inflation have created affordability challenges for many Americans. Still, mortgage rates are down more than a percentage point from recent peaks reached last fall. On Friday the National Association of Realtors said its pending home sales index, a measure of homes going under contract, jumped 8.3% in December after registering no change in November.

Will Feuer contributed to this article.

Write to Harriet Torry at [email protected] and Nick Timiraos at [email protected]