By Jeanna Smialek
Inflation continued to recede in August, paving the way for the Federal Reserve to lower interest rates for the first time since early 2020 at their meeting next week.
But signs of stubbornness lingered under the surface, which caused investors to ramp up their bets that central bankers will lower borrowing costs by a quarter-point from their current 5.33%, not the larger half-point that some had previously seen as possible.
The overall consumer price index climbed 2.5% in August from a year earlier, a notably cooler pace of inflation than July’s 2.9% and down sharply from a peak of 9.1% back in 2022.
But the number that was getting attention from Wall Street on Wednesday was a monthly “core” measure. That gauge shows how much prices picked up between July and August after stripping out food and fuel prices, both of which can be volatile. And it ticked up to 0.3%, slightly more than economists had expected.
The details made that move important: It came as a measure of housing prices proved surprisingly stubborn. Shelter costs make up a big chunk of overall inflation, so if they are not cooling as expected, they could prevent the pace of price increases from returning fully to the Fed’s goal.
Still, that complication was not enough to change the overall narrative. Inflation has been gradually slowing for some time, paving the way for the Fed to shift its policy stance as officials try to strike a careful balance in which they fully defeat rapid price increases without tanking the economy in the process.
“I still think they are confident enough to proceed with rate cuts, but it suggests: Don’t go super fast here,” said Laura Rosner-Warburton, senior economist and founding partner at MacroPolicy Perspectives. “We’re not completely out of the woods.”
High interest rates work like brakes tapped on the economy. They cause economic activity to slow down, and as demand recedes, it becomes more difficult for businesses to raise prices. But Fed officials want to tread carefully. Keeping rates too high for too long could slow conditions down too much, spurring unemployment and risking a recession.
Fed officials don’t want to cut too much too quickly if there is a chance that price increases are not fully under control, because doing so could heat the economy back up and make inflation a persistent problem. But they also don’t want to drag their feet and risk the health of the labor market.
That is why officials have been closely watching incoming inflation and employment data as they contemplate how quickly to move, both at their two-day meeting that concludes next Wednesday and in the months to come.
Policymakers will lay out a snapshot of their plans for the future next week, when they are set to release fresh quarterly economic forecasts. Those will outline a rough path ahead for rates.
The Fed’s move next week will mark a turning point in the economy, providing the clearest statement yet that central bankers believe they are winning the war against inflation, even if the victory is not yet complete.
After first taking off in early 2021, inflation has now been cooling for more than two years, and it is at last approaching a normal pace.
Fed officials officially aim for 2% inflation, although they define that goal using the personal consumption expenditures price index. That measure uses some of the data from Wednesday’s consumer price index, but it comes out at more of a delay. It too has been moderating.
Rosner-Warburton said that she expects housing costs to fade in the months to come. But there could be bumps along the way. She expects used car costs to pick back up this fall, for instance.
“The direction of travel is still clear,” she said. “It’s about the speed, and whether it’s linear.”
As price increases return to the Fed’s goal, consumers may begin to feel like they are catching up. Wage growth has been faster than price increases for more than a year now by several measures.
That is good news for the Biden administration, which has struggled to take credit for its economic wins — including a solid job market — as rising prices undermined consumer confidence.
“With inflation coming back down close to normal levels, it is important to focus on sustaining the historic gains we have made for American workers during this recovery,” Lael Brainard, head of the White House National Economic Council, said in a statement following the report.
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