The Fed’s favorite inflation gauge slowed in October

Inflation showed signs of easing but remained stubbornly high in October as a series of economic data underlined that a return to normal price increases could take time.

Prices as measured by the Personal Consumption Expenditure Index, the metric the Federal Reserve is watching most closely, rose 6% in the year to October, the report said, in line with what economists said. had predicted in a Bloomberg survey. That was down from a 6.3% increase in the year through September.

A core price measure that excludes food and fuel costs, a metric the Fed is watching closely for a sign of what might follow with inflation, edged down to 5%. It has hovered around this level throughout the year, so while the recent moderation is a step in the right direction, it is far from conclusive.

Other economic data provided further evidence of continued economic momentum. Consumer spending was accelerating, incomes were rising and unemployment insurance claims remained subdued, according to reports on Thursday, suggesting the economy remains resilient, with workers benefiting from plentiful jobs and using their savings to continue to work. do their shopping. Sustained demand and a strong labor market could help prevent a sharp recession, but they could also help companies keep raising prices, prolonging the return to normal inflation.

The Fed is watching developments in inflation closely as it tries to determine how far to raise interest rates and how long to keep them high. Central bankers have raised borrowing costs to nearly 4% this year from near zero in March, including a rapid series of three-quarter point moves. Fed Chairman Jerome H. Powell made it clear on Wednesday that central bankers are poised to slow their rate hikes in December. The question now is when and at what level they will stop raising borrowing costs.

Powell suggested that rates will likely need to climb slightly above the 4.6% peak that officials had predicted in September when economic forecasts were last released. Investors now see rates peaking between 4.75% and 5% before falling slightly at the end of 2023, based on market prices.

“Continued increases will be appropriate,” Powell said this week. “We have a long way to go to restore price stability.”

Thursday’s inflation data follows a more timely report on the consumer price index, which showed price increases began to moderate in October. CPI data is closely followed because it is released more quickly and feeds personal consumption expenditure data. But the Fed uses the PCE numbers as its official inflation target.

Central bankers are aiming for 2% annual inflation on average and over time, so the current rate of increase is still much faster than their target. Given that so-called core inflation has been stuck around 5% all year, the Fed has been reluctant to make much of the recent drop in global prices.

“In 2022, core inflation rose a few tenths above 5% and fell a few tenths below, but it mostly moved sideways,” Powell said this week, explaining that demand will have to remain slower, inflation of goods will have to continue to subside. , and the labor market will have to rebalance to bring inflation back to normal.

Many economists believe inflation will slow significantly in 2023 as market-based rent prices are now starting to fall, supply chain issues have eased, and consumers have shifted their spending from goods to homes. services, which should help moderate prices for physical products like sofas and clothing.

Goldman Sachs economists said in their mid-November forecast that inflation is expected to fall to around 3% by the end of 2023, after suppressing food and fuel prices. But this time last year they said they expected core inflation to fall to 2.3% by the end of 2022.

“Forecasts have been predicting such a drop for over a year, while inflation has stubbornly moved sideways,” Powell said this week, adding later that “we’re going to have to be humble and skeptical about the forecast. for a certain time”. .”

It is difficult to predict what will happen next with inflation, in part because the economy, which had slowed considerably this year, appears to be resilient and perhaps even reaccelerate in the face of rising prices and interest rates. interest.

Consumption rose 0.8% in October from the previous month, data showed on Thursday, down from a previous gain of 0.6%. Adjusted for inflation, expenses increased by 0.5%.

More recent anecdotal data suggests the holiday shopping season is off to a good start: Retail sales over the Thanksgiving weekend were up 10.9% year over year, excluding cars and unadjusted for inflation, based on Mastercard data.

Americans are buoyed in part by a strong job market that helps them earn more money, and by one-time payments from states, some of which still have stimulus funds to disperse or benefit from strong tax revenues.

Personal income rose 0.7% in October and 0.4% after adjusting for inflation, data showed on Thursday. This is the largest inflation-adjusted increase since July.

Personal income includes government social benefits, which helped boost it this month, “primarily reflecting state-issued one-time refundable tax credits,” the Bureau of Economic Analysis said in its statement.

At the same time, people seem to be becoming more price-sensitive as their savings dwindle and expensive food and gasoline strain family budgets. Stores have resumed offering product discounts to attract and retain customers, which could help curb inflation, if drastic enough.

Consumers could become even more sensitive next year if Fed policy actions in 2022 trickle down to the economy and dampen business expansion, hiring and wage gains, as many economists predict. and as households draw on the stocks of savings they have accumulated over the course of the course. of the pandemic.

“We expect spending growth to slow, due to a significant increase in the pace of layoffs and a slowdown in hiring,” wrote Ian Shepherdson of Pantheon Macroeconomics in a research note. “We think people will be less willing to deplete their savings in the face of a deteriorating job market.”

Fed officials are watching both spending data and the jobs picture as they try to guess what might come next with inflation. Wage growth has been strong in recent months, and it may be difficult for inflation to moderate all the way back to normal without a slowdown in wage growth.

Indeed, the prices of services – those of haircuts, manicures, vacations, etc. – are strongly influenced by wage gains. When companies spend more on labor, they are likely to try to pass these higher costs on to consumers in the form of higher prices.

America will get a fresh look at labor market and wage developments on Friday, when the Labor Department is expected to release November jobs data.