As a year of record-high consumer prices comes to a close, inflation is finally showing some signs of meaningfully relenting, allowing the U.S. central bank to begin easing its monthslong campaign of aggressively hiking interest rates.
On Dec. 14, the Federal Reserve announced that it would raise rates by an expected half of a percentage point after several 0.75 percentage-point increases this year. With the decades-high hikes, the Fed hoped to cool an overheated economy by curbing consumer purchasing power and stemming demand amid widespread supply shortages.
The Fed’s decision this month followed new Labor Department data showing that inflation grew at a slower pace than expected in November, marking two consecutive months of deceleration. The consumer price index, which measures what people pay for a range of goods and services, rose by 7.1% compared to the same time last year, “the smallest 12-month increase since the period ending December 2021,” the Bureau of Labor Statistics said.
Fed Chairman Jerome Powell said “financial conditions have tightened significantly in response” to the central bank’s actions and that it is “seeing the effects on demand in the most interest-sensitive sectors of the economy,” such as the housing market.
“It will take time, however, for the full effects of monetary restraint to be realized, especially on inflation,” Powell said in prepared remarks. “In light of the cumulative tightening of monetary policy and the lags with which monetary policy affects economic activity and inflation, the Committee decided to raise interest rates by 50 basis points today, a step down from the 75-basis point pace seen over the previous four meetings.”
The inflation data signal potential relief for consumers’ wallets in the year ahead as credit card debt rapidly increases and suggests that the Fed’s policy decisions this year are beginning to have a noticeable effect. “Cooling inflation will boost the markets and take pressure off the Fed for raising rates, but most importantly, this spells real relief starting for Americans whose finances have been punished by higher prices. This is especially true for lower-income Americans who are disproportionately hurt by inflation,” Navy Federal Credit Union corporate economist Robert Frick told CNBC.
President Joe Biden, whose approval numbers dipped this year as the country faced steep prices on everyday goods, also embraced the new inflation figures, expressing cautious optimism.
“In a world where inflation is rising at double digits in many major economies around the world, inflation is coming down in America. Make no mistake — prices are still too high. We have a lot more work to do. But things are getting better, headed in the right direction,” Biden said on Dec. 13.
Nevertheless, the administration has not yet escaped the possibility of unleashing a recession, and Powell indicated that further economic pain is likely on the horizon. “The inflation data received so far for October and November show a welcome reduction in the monthly pace of price increases. But it will take substantially more evidence to give confidence that inflation is on a sustained downward path,” the Fed chairman said. He noted further that “50 basis points is still a historically large increase, and we still have some ways to go.”
“Reducing inflation is likely to require a sustained period of below-trend growth and some softening of labor market conditions. Restoring price stability is essential to set the stage for achieving maximum employment and stable prices over the longer run,” he said.
On Dec. 14, the Fed released its most recent economic projections, showing that unemployment is expected to hit 4.6% next year, compared to the 4.4% that the central bank predicted in September. So far, strong employment numbers this year have contributed to many economists’ decision to not declare America’s economy to be in recession territory despite an overall slowdown.
The fresh economic projections also show inflation stubbornly sticking around at higher rates than previously thought in the years to come. Some economists say the Fed will need to keep applying pressure to the labor market to rein in inflation since higher wages and strong job numbers allow some consumers to keep spending.
“Over time, the core-core CPI — we strip out rents and an array of COVID-sensitive components — tends to track the rate of growth of wages, which is why Chair Powell and other Fed officials want to see wage growth moderating,” said Ian Shepherdson, the chief economist at Pantheon Macroeconomics. “No matter how far inflation is pushed down by margin recompression over the next year or so, it will not stay down with wage growth close to 5%.
“Most Fed officials appear to want to see wages rising by a bit less than 4%,” Shepherdson continued, according to Yahoo! Finance. “We think that’s realistic as an objective for the middle of next year, but it will require a modest increase in the unemployment rate and a clear downshift in inflation expectations.”
At a press conference, Powell said that a so-called “soft landing,” in which the Fed reels in inflation without triggering a recession, becomes “more possible” with inflation numbers that continue to slow. But he stopped short of making any firm predictions: “I don’t think anyone knows whether we’re going to have a recession or not, and if we do, whether it’s going to be a deep one or not. It’s not knowable.”
In his prepared remarks, Powell said the central bank is not done raising interest rates. “We continue to anticipate that ongoing increases will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time,” Powell said.
“The Fed is taking away the punchbowl just as the party was getting started,” Chris Zaccarelli, the chief investment officer at the Independent Advisor Alliance, told Reuters. “Despite a lower-than-expected CPI inflation report yesterday, the Fed’s statement today signals that they are going to be even more restrictive than they had previously indicated.”
Powell said that “[p]rice pressures remain evident across a broad range of goods and services” and that “Russia’s war against Ukraine has boosted prices for energy and food and has contributed to upward pressure on inflation.”
The Fed began hiking interest rates for the first time in years in March, following Russia’s invasion of Ukraine and the resulting disruptions to supply chains and the global energy sector. In June, the Fed approved its first 0.75-point increase since 1994 after a particularly high CPI reading for the month prior.
In addition to sky-high gas prices, consumers saw the cost of groceries rise (especially meat and produce) earlier in the year. Since the Fed began raising interest rates, mortgage rates have sharply increased as well, resulting in the start of a long-awaited cooldown in the real estate market.
Food and fuel prices have since started to relent, according to the Bureau of Labor Statistics’s most recent inflation data. “The energy index increased 13.1% for the 12 months ending November, and the food index increased 10.6% over the last year; all of these increases were smaller than for the period ending October,” the BLS said.
However, housing prices remain high, the BLS said, with shelter being the key driver of inflation for November, “more than offsetting decreases in energy indexes.”
“The indexes for shelter, communication, recreation, motor vehicle insurance, education, and apparel were among those that increased over the month. Indexes which declined in November include the used cars and trucks, medical care, and airline fares indexes,” the BLS said.
Blackrock’s chief investment officer of global fixed income, Rick Rieder, said that with the latest CPI report “and what we think is a trend now in place for lower and more normalized inflation readings, the Fed can transition to sitting back and watching their efforts bear fruit (and bring the prices of those and other goods and service-related items down).”
“At the same time, the central bank will attempt to keep employment as well supported as possible, but the Fed has recognized that it may have to sacrifice some degree of employment in the short-term in order to bring prices down,” Rieder said, per Yahoo! Finance.
“Still, if data such as today’s suggest a real trend that the momentum of inflation is lower, we could then see the Fed pause over the next few months at a still restrictive policy-rate,” Rieder said. “But not one which would put potentially excessive pressure on the economy, and particularly on the interest-sensitive parts of the economy that have already begun to show signs of real (and anticipated) weakness.”