U.S. Federal Reserve officials got encouraging data on Friday suggesting inflation is cooling, a welcome development after stronger-than-expected price increases earlier in the year raised doubts over how well monetary policy was doing its job.
But while progress on a month-to-month basis is increasingly clear, the road to the Fed’s 2% inflation goal – measured in year-over-year terms – is likely to be long, complicating discussions about when to cut interest rates. “We are getting evidence that (policy) is tight enough,” San Francisco Federal Reserve Bank President Mary Daly told CNBC in an interview just minutes after a Bureau of Economic Analysis report showed inflation did not rise from April to May. “It’s challenging to look anywhere and not see monetary policy working: we have growth slowing, spending slowing, the labor market slowing, inflation coming down.”
At the same time, Friday’s inflation data indicates further progress is still required. The personal consumption expenditures price index rose 2.6% from the past year. The Fed’s target is 2%.
The Fed has kept its policy rate in the 5.25%-5.5% range since last July when it delivered what U.S. central bankers say is mostly likely to be the last rate hike of an aggressive campaign begun in March 2022 to fight high inflation. The central bank stated it won’t consider rate cuts until it is confident that inflation is consistently on track to reach its 2% target.
Traders on Friday bet that the latest inflation figures will firm up that confidence, ratcheting up their bets the Fed will deliver a first-rate cut in September and another in December. Short-term interest-rate futures are now pricing in about a 70% chance that the policy rate will be in the 4.75%-5% range by year’s end.
“May’s inflation print was well below the threshold the Fed needs to be comfortable and breaks the string of high inflation prints we’ve seen since the start of the year,” wrote Natixis economist Christopher Hodge.
But the optics for rate cuts could be challenging. Even if inflation, as measured from month to month, rises slightly so that, annualized, it is in line with the Fed’s 2% target, the super-low inflation readings in the second half of last year mean it would take until the end of the year to see progress in the year-over-year readings.
That could force Fed officials into a difficult debate when the month-to-month numbers provide enough signal to light the fuse on rate cuts and stop referring to inflation as “elevated” in their policy statement.
Daly on Friday reiterated that inflation is still too high, and said she expects it to stay above 2% year-over-year through the end of 2025. Earlier this week, Fed Governor Lisa Cook forecasted stable inflation this year with a sharper decline expected next year.
Recently, Fed policymakers have avoided committing to specific timelines for rate cuts, instead discussing different scenarios that could influence their decision to cut rates sooner or later.
Atlanta Fed President Raphael Bostic is one of the few U.S. central bankers who have specified a potential timeline for a rate cut. “I continue to believe conditions will likely call for a cut in the federal funds rate in the fourth quarter of this year,” he said on Thursday.
PCE inflation peaked in June 2022 at 7.1%.
“The big picture for me is that there has been tremendous progress but there is still a distance to travel,” he said, and the details of the inflation data will matter to the Fed’s assessment of further progress. “There have been periods when one or a small number of items move the headline number. I want to look through that and see if other dimensions give us confidence…Even if the topline stays where it is.”
(Source: Reuters)
