WASHINGTON — It was the most painful inflation Americans had experienced since 1981, when “The Dukes of Hazzard” and “The Jeffersons” topped the TV charts. Yet the Federal Reserve now appears to be on the verge of beating it – and without the rise in unemployment and the deep recession that would accompany it, as many economists had predicted.
Inflation has fallen more or less steadily since peaking at 9.1% in June last year. And when the Fed's favorite inflation gauge for November is reported next week, it will likely show that annualized inflation has actually fallen just below the Fed's 2% target over the past six months, UBS economists estimate.
The cost of goods – such as used cars, furniture and appliances – has fallen for six months in a row. Compared to a year ago, commodity prices are unchanged, driven by improved global supply chains.
Housing and rental costs, a key driver of inflation, are growing more slowly. Wage growth has also cooled, although it still exceeds inflation. Milder wage growth generally eases pressure on restaurants, hotels and other employers to raise prices to cover their labor costs.
“I think it's really good to see the progress we're making,” Chairman Jerome Powell said Wednesday at a news conference after the Fed's latest policy meeting. “If you look at the six-monthly measures, you see very low figures.”
On Friday, the Congressional Budget Office, a nonpartisan agency, estimated that inflation will fall to 2.1% by the end of next year.
There are likely to be bumps on the road to fully controlling inflation, officials say. Powell emphasized that “no one is declaring victory.” And he reiterated that the central bank wants to see further evidence of falling inflation before it can be confident of a sustainable return to the 2% target.
Yet many economists, normally a cautious crowd, are now willing to declare that inflation is almost back under control after more than two years of imposing hardships on millions of American households.
“It appears that inflation has returned to 2%,” said Tim Duy, chief economist at SGH Macroeconomics. “It appears the Fed has won that battle.”
Price spikes abroad are also subsiding, with both the Bank of England and the European Central Bank leaving their benchmark interest rates unchanged this week. Although inflation is still 4.6% in the UK, it has fallen to 2.4% in the twenty countries that use the euro.
With inflation cooling, Powell said the 19 officials on the Fed's policy-setting committee had discussed the prospects for rate cuts at this week's meeting. The officials also predicted that the Fed will cut its key interest rate three times next year.
That stance marked a dramatic shift from the rate hike campaign the Fed began in March 2022. From then on, the central bank raised its benchmark interest rate eleven times, from near zero to around 5.4%, the highest level in 22 years, in an effort to lower interest rates. slow lending, spending and inflation. The result was much higher costs for mortgages, car loans, business loans and other forms of credit.
Powell's suddenly more optimistic words and the Fed's interest rate cut projections sent stock market indexes soaring this week. Wall Street traders now project a roughly 80% probability that the first rate cut will come at the Fed's March meeting, and they predict a total of six cuts in 2024.
On Friday, John Williams, president of the Federal Reserve Bank of New York and Powell's top lieutenant, tried to pour some cold water on those expectations. Speaking to CNBC, Williams said it was “premature to even think” about whether to cut rates in March. But he also said his prediction was that inflation would fall “sustainably” to 2%.
This week's events marked a departure from just two weeks ago, when Powell had said it was “premature” to say whether the Fed had raised its policy rate high enough to fully overcome high inflation. On Wednesday, he suggested that the Fed is almost certainly done with rate hikes.
Recent data seemed to have contributed to a change in Powell's thinking. On Wednesday, wholesale prices came in lower than economists expected. Some of these figures are used to construct the Fed's preferred inflation gauge, which as a result is expected to show much lower inflation numbers next week.
Powell said some Fed officials even revised their economic projections on Wednesday, not long before they were released, in light of the lower-than-expected wholesale price report.
“The speed at which inflation has fallen is like an earthquake at the Fed,” Duy wrote in a letter to clients on Wednesday.
And yet, in the meantime, the economy continues to grow, defying widespread fears from a year ago that 2023 would trigger a recession, a result of the much higher interest rates the Fed has come up with. A retail sales report on Thursday showed that consumers increased their spending last month, likely encouraged by higher discounts that will also lower inflation. Such trends support the growing belief that the economy will achieve an elusive “soft landing” in which inflation is defeated without an associated recession.
“We think the Fed can't believe its luck: We're back to 'flawless disinflation,'” Krishna Guha, an economic analyst at investment bank Evercore ISI, wrote in a client note.
Economists acknowledge that the Fed's rapid rate hikes have contributed to the decline in inflation. In addition, a recovery in global supply chains and a rise in the number of Americans – and recent immigrants – looking for work have helped slow the pace of wage growth.
Jon Steinsson, an economics professor at the University of California, Berkeley, said that by aggressively raising their key interest rate in about 15 months — the fastest pace in four decades — Fed officials kept U.S. inflation expectations largely in check. Expectations can be self-fulfilling: When people expect higher inflation, they often take actions, such as demanding higher wages, which can push prices even higher.
“They played a crucial role,” Steinsson said.
However, a sustained decline in inflation is not guaranteed. A wildcard is the rental prices. Real-time measurements of the rental contracts of new apartments show that these costs are rising much more slowly than a year ago. It takes time before that data ends up in the government figures. Excluding what the government calls “shelter costs” – rents, the cost of homeownership and hotel prices – inflation rose just 1.4% last month from a year earlier.
But Kathy Bostjancic, an economist at Nationwide, said she worries that a shortage of available housing could raise housing costs in coming years, potentially keeping inflation high.
The Fed's rate hikes could even prolong the deficit, according to Bostjancic. Today's higher mortgage rates may limit housing construction and discourage current homeowners from selling. Both trends would keep the supply of housing in check and prices high.
Still, Fed officials appear confident in their predictions that inflation is steadily slowing. In September, 14 of 19 Fed policymakers had said there were risks that inflation would rise faster than they expected. This month, only eight said so.
“Their projections have largely come down, and they think there's less chance of an inflation flare-up,” said Preston Mui, a senior economist at Employ America, an advocacy group.