Inflation has risen in the past month, supporting the Fed’s caution about rate cuts

Inflation rose slightly overall in February and a closely watched measure of underlying price increases was stronger than economists expected.

The new data underlines that fully returning inflation to a normal pace is likely to be a bumpy process – and supports the Federal Reserve’s decision to take a cautious approach in considering when and how much to cut rates .

The consumer price index rose by 3.2 percent last month compared to a year earlier, compared to 3.1 percent in January. That’s down significantly from a high of 9.1 percent in 2022, but it’s still faster than the roughly 2 percent that was normal before the pandemic.

After factoring out volatile food and fuel costs to get a better sense of the underlying trend, inflation came in at 3.8 percent, slightly faster than economists had predicted. And on a month-on-month basis, core inflation rose slightly faster than expected as airline and auto insurance prices rose, even as a closely watched housing measure rose more slowly.

Overall, the report is the latest sign that fully reducing inflation will likely take time and patience.

“It just underscores the Fed’s caution about the inflation outlook,” said Kathy Bostjancic, chief economist at Nationwide Mutual.

So far, inflation has fallen steadily and relatively painlessly: unemployment continues to hover below 4 percent and growth has been unexpectedly strong in 2023, even as the Fed has raised interest rates to the highest level in more than two decades.

Fed officials have debated how long to leave rates at their current level, about 5.3 percent. Higher borrowing costs make it expensive for people to borrow to buy a home or expand a business, and that can weigh on the economy over time. The Fed has tried to curb demand enough to get inflation under control, but officials want to avoid crushing growth to the point of causing widespread job losses or a recession.

Some economists worry that slowing inflation over time could be more difficult than it has been to make progress so far. And Fed officials want to avoid cutting rates too early, only to find that inflation has not yet been fully suppressed.

“We don’t want a situation where it turns out that the six months of good inflation data we had last year turned out not to be an accurate signal of where underlying inflation lies,” said the Fed’s Jerome H. Powell. chairman, he said during his testimony before Congress last week. That’s why, he said, the Fed is being cautious.

But Mr. Powell also said last week that if the Fed was confident inflation had fallen enough — “and we are not far from that,” he added — it would be appropriate to cut rates.

“Overall, the view that there is disinflation in the economy is still intact,” Ms Bostjancic said after the new inflation report. “But it keeps them in a wait-and-see attitude before they really have the confidence that they need to lower interest rates.”

The Fed targets an annual inflation rate of 2 percent. It defines that target using a separate but related inflation index, the measure of personal consumption expenditures. That index includes some data from the consumer price index figures, but is released with a longer delay.

Some economists wonder whether price increases will continue to level off smoothly toward the central bank’s target. If inflation for services – things like housing and insurance – proves to be more persistent than expected, it could become more difficult to completely eradicate overall price increases.

The report published on Tuesday offered good news in that regard. A closely watched measure that effectively tracks how much it would cost to rent a home someone owns rose more moderately. Economists had been nervously watching that “equivalent rent from the owners‘measure after it accelerated in January.

Rents for primary residences, on the other hand, rose slightly faster, to 0.5 percent on a monthly basis, compared to 0.4 percent in January.

“Over the past month, interest rates have fallen so much that I’m not worried about the recovery at all,” said Laura Rosner-Warburton, senior economist at MacroPolicy Perspectives, of the rise in rents. She said the rental measures and the owner’s rent measures together “told a story about moderating the cost of shelter.”

Goods have had a negative impact on inflation recently, but there were some exceptions in February. For example, clothing prices have been declining on a monthly basis lately, but have increased in price over the past month.

Fed officials are meeting on March 19 and 20 and are widely expected to leave rates unchanged at that meeting. They will release a new set of economic projections after the meeting, showing how much they expect to cut rates in 2024. According to their latest estimates, published in December, officials had expected to make three rate cuts this year.

Investors think the Fed could start cutting rates in June, later than they expected earlier this year.

“We still believe there is enough disinflationary pressure to materialize,” economists at Capital Economics wrote in a note responding to the report. They still think the Fed will start cutting rates in June, “by which time there will be more evidence” of further cooling.