Cooling U.S. inflation makes case for Fed to slow rate hikes in September

May 27 (Reuters) – Evidence that U.S. inflation is cooling won’t keep Federal Reserve policymakers off plans to raise interest rates by half a percentage point at their June and July meetings, but if the trend continues, it could That prompted the Fed to turn to a modest rate hike in September.

The U.S. Commerce Department’s report on Friday showed that the personal consumption expenditures (PCE) price index rose 6.3% in April from a year earlier.read more

That’s still more than three times the Fed’s 2% target.

Sign up now for free and unlimited access to Reuters.com

Reuters Image Reuters Image

While prices are still rising, the pace of growth has slowed compared to the previous month. April’s PCE reading marked the measure’s first deceleration since November 2020.

The core PCE index, which strips out food and energy prices to give a clearer picture of longer-lasting price pressures, rose 4.9% – again uncomfortably high but marking a second straight monthly slowdown from a likely peak of 5.3% in February.

The fall in core inflation is especially good news for the central bank, while new evidence suggests that household spending is continuing to grow even as prices continue to rise rapidly. Friday’s report showed consumer spending rose 0.9% last month.

“While inflation levels in the 4% range are still too high for the Fed, we see a trend in the right direction,” National Economist Dan Hadden wrote in a note. As long as inflation continues to stabilize or moderate, “it could give (the Fed) more flexibility later in the year.”

The Fed has raised rates by three-quarters of a percentage point so far this year, and most policymakers expect to raise rates by a few 0.5 percentage points, recent public comments and minutes from the May meeting show.

This will bring the cost of overnight interbank borrowing into the 1.75%-2% range by the end of July. Expectations of those rate hikes appeared to have dented demand in the housing market, with home prices surging, but a surge in mortgage rates helped push down April home sales for a sixth straight month.

The weakness suggests that price increases will also moderate in the coming months, with Comerica’s Bill Adams saying inflation data will start to moderate by the end of the year or early 2023.

As early as the Fed’s May meeting, “some” policymakers believed that “monthly data may suggest that overall price pressures may no longer worsen.”

The Fed’s general hope is to get through this era of price shocks and uncertainty, with a worst-case scenario of slower growth rather than an outright recession leading to a sharp rise in unemployment.

Lydia Boussour of Oxford Economics wrote on Friday: “Amid growing pessimism about the state of the U.S. consumer, today’s report offers some reassurance that in the face of historic inflation and rising borrowing costs, the economy will The main pillar of the economy remains strong.”

U.S. stocks, which have fallen rapidly in recent weeks, rose after inflation data on Friday as investors assessed how the Federal Reserve’s shift in monetary policy could slow the economy and hope the Fed’s quest for a “soft landing” may still be achievable.

Traders in futures contracts linked to the Fed’s policy rate continued to bet that the Fed would cut rates to 25 basis points in September.

To achieve this, the rest of the world will need to cooperate.

The impact of the war in Ukraine on world commodity prices and the ongoing coronavirus lockdown in China are two risks that the Fed has absolutely no control over.

Fed policymakers also said they are closely watching inflation expectations for signs that the current high inflation is taking root in the psychology of U.S. households and businesses. Recent data suggest that these risks are at least not worsening.

Reuters Image Reuters Image

Meanwhile, Fed staff continue to expect headline PCE inflation to moderate to 4.3% by the end of this year and 2.5% by the end of next year, as “historically large” tightening of financial conditions is felt across the economy , minutes from the Fed meeting this week show.

Sign up now for free and unlimited access to Reuters.com

Reporting by Ann Saphir in Berkeley, California, Howard Schneider in Washington and Lindsay Dunsmuir in Scotland Editing by Matthew Lewis

Our standard: Thomson Reuters fiduciary principles.