Fed’s preferred measure of inflation picks up slightly as signs of persistence remain

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Inflation has fallen sharply across many advanced economies, but central banks have so far been unwilling to cut interest rates while they are not absolutely certain that inflation is under control.
Inflation has fallen sharply across many advanced economies, but central banks have so far been unwilling to cut interest rates while they are not absolutely certain that inflation is under control.

The Fed’s preferred measure of inflation ticked up in January in a sign that the central bank will likely have to delay cutting interest rates for a few more months.

Figures from the Bureau of Economic Analysis showed the core personal consumption expenditure (PCE) index rose 0.4 per cent on the previous month, in line with economists’ expectations but up from 0.1 per cent in December.

The monthly increase reflects the relatively stubborn rate of services prices, which increased 0.6 per cent on the previous month.

On an annual basis, however, core PCE came in at 2.8 per cent, down from 2.9 per cent the month before.

PCE inflation differs from the traditional measure of inflation, the consumer price index (CPI), by including a wider scope of data. CPI uses data from household surveys, while PCE uses data from suppliers, non-profits and the country’s GDP data.

The core measure strips out volatile components such as food and energy. It is closely monitored by the Fed, who consider it to be the most accurate gauge of inflationary pressure in the US.

CPI inflation slowed less than expected in January, falling to 3.1 per cent. Economists had expected it would fall to below three per cent.

“The surge in core PCE prices in January was largely as expected after the hot CPI and PPI reports,” Paul Ashworth, chief North American economist said.

The persistence of inflationary pressures suggests the Fed will hold fire on cutting interest rates until the summer.

At the beginning of the year, investors thought that the Fed would start cutting interest rates in March. However, stubborn inflation, strong growth and a resilient labour market have all contributed to push back the timing of the first rate cuts.

Interest rates stand in a range of 5.25-5.50 per cent, their highest level for 23 years.

The world’s largest economy grew 2.5 per cent last year, a stronger performance than in 2022. Given the strength of the US economy, the Fed can afford to wait until inflation is definitely under control before cutting interest rates.