Federal Reserve’s preferred inflation gauge increased; sign of still-elevated prices

WASHINGTON — An inflation gauge favored by the Federal Reserve rose in January, the latest sign that the slowdown in U.S. consumer price increases is happening unevenly from month to month.

The government reported Thursday that prices rose 0.3% from December to January, compared with 0.1% in the previous month. But in a more encouraging sign, prices rose just 2.4% from a year earlier, compared with an annual increase of 2.6% in December and the smallest increase in almost three years.

The year-on-year slowdown in inflation will certainly be welcomed by the White House as President Joe Biden seeks re-election. Still, even though average salaries have exceeded inflation over the past year, many Americans remain frustrated that overall prices are still well above where inflation broke out three years ago. That sentiment, evident in many polls, could threaten Biden’s re-election bid.

Inflation, as measured by the Fed’s preferred benchmark, fell steadily last year after peaking at 7.1% in the summer of 2022. Supply chain problems have eased, driving down the costs of parts and raw materials, and a steady flow of job seekers has made it easier for employers to limit wage increases, one of the drivers of inflation. Still, inflation remains above the central bank’s annual target of 2%.

Excluding volatile food and energy costs, prices rose 0.4% from December to January, compared with 0.1% in the previous month. And compared to a year earlier, these so-called “core prices” rose by 2.8%, up from 2.9% in December. Economists consider core prices to be a better indicator of the likely path of future inflation.

Some of January’s inflation reflects the fact that companies often raise prices in the first two months of the year, keeping January and February price data high compared to the rest of the year. But the cost of hospital and physician services is also rising to offset significant pay increases for nurses and other in-demand health care workers.

This trend could help keep inflation high in the coming months. But by early spring, most analysts expect prices to recover to the milder pace of increase seen in the second half of 2023, when inflation eased to 2% annualized.

The rise in inflation in January helps explain concerns among many Fed officials, including Chairman Jerome Powell, about a possible too-quick rate cut this year. An influential official, Christopher Waller of the Fed’s Board of Governors, said this month that he would like to see two more months of inflation data after January to determine whether prices were cooling sustainably toward the Fed’s target level.

Starting in March 2022, the Fed raised rates eleven times to tackle the worst wave of inflation in four decades. These interest rate increases have helped to drastically cool inflation. But they have also made borrowing much more expensive for consumers and businesses. In particular, high interest rates on loans have stifled sales in the crucial home-buying sector of the economy. Conversely, Fed rate cuts, whenever they occur, would ultimately lower borrowing costs across the economy.

Thursday’s inflation data echoes figures released earlier this month that showed the government-tracked consumer price index also rose faster in January than in previous months. The Fed favors the measure reported Thursday in part because it takes into account changes in the way people shop when inflation rises — for example, when consumers shift away from expensive national brands in favor of cheaper store brands.

Several Fed officials have said they are optimistic that inflation will continue to fall back to the Fed’s target level, with some downplaying the recent price increase as a one-time jump.

“The path will continue to be bumpy, and we should not overreact to individual data measurements,” Susan Collins, president of the Federal Reserve Bank of Boston, said Wednesday. “I remain what I call a ‘realistic optimist’ if I believe that the economy is heading towards 2% inflation on a sustainable basis, while the labor market remains healthy.”

Some other officials sound more uncertain. Jeffrey Schmid, the new president of the Federal Reserve Bank of Kansas City, said this week: “When it comes to over-inflation, I believe we are not out of the woods yet.”

Outside of the Fed, most economists foresee a steady, if choppy, slowdown in inflation in the coming months. Economists at Goldman Sachs predict that core inflation, as measured by the Fed’s preferred gauge, will fall quickly to just 2.2% in May – low enough for the Fed to initiate rate cuts in June.