August Saw a Decrease in the Inflation Measure Preferred by the Federal Reserve

Federal Reserve officials received positive news in their fight against inflation as a key inflation measure continued to slow in August. This provides further evidence that the economy is returning to normal after the pandemic and higher interest rates are helping to curb rapid price increases.

The Personal Consumption Expenditures Index, which the central bank uses to define its 2 percent inflation goal, rose slightly faster last month due to higher gas prices. It increased by 3.5 percent in August compared to the previous year, up from 3.4 percent in July.

However, when food and fuel costs are excluded, a “core” inflation measure that the Fed closely monitors is showing signs of cooling. The core inflation measure increased by 3.9 percent from the previous year, down from 4.3 percent in July. Month-on-month, it only rose by 0.1 percent, indicating a very slow pace.

This is a positive development for Fed policymakers, who have been raising interest rates to slow down the economy and stabilize price increases. While the economy has performed better than expected, a sluggish housing market and a gradual return to normal in the car market have contributed to the decline in key prices, such as automobiles and rents.

Additionally, supply chain disruptions that caused shortages and price hikes in 2021 have gradually resolved, allowing costs for many goods to stabilize or even decrease slightly.

Omair Sharif, founder of the research firm Inflation Insights, stated that although the latest inflation report is a positive step, the Fed may still be cautious about declaring that core inflation has sustainably slowed.

Given the progress made, central bankers are now considering whether further interest rate hikes are necessary. They opted to keep interest rates unchanged at their meeting this month, but signaled the possibility of one more rate increase later this year. However, considering the strength of the economy, officials have indicated the need to maintain higher interest rates for a longer period to ensure sustainable inflation levels.

Jerome H. Powell, the Fed’s chair, mentioned during a news conference that they are now moving more cautiously after having acted quickly. According to Mr. Sharif, the Fed may hold off on a rate move in November, but an increase in December is still possible if inflation slightly picks up in the autumn.

Market pricing suggests that there is approximately a one-third chance of a rate increase in December, based on investor expectations. Long-term bond yields have also risen in recent weeks, indicating that Wall Street believes the Fed will maintain its policy rate at a higher level for a longer duration. Stocks reacted positively to Friday’s inflation report.

Ian Shepherdson, chief economist at Pantheon Macroeconomics, described the report as “very welcome news” and stated that the emerging downward trend in inflation is becoming clear. However, the big question now is whether inflation can fully fade without causing a significant economic slowdown.

So far, the economy has shown resilience, with retail sales figures and company earnings calls indicating that American consumers continue to spend despite higher borrowing costs. However, Friday’s report also showed a slight slowdown in personal consumption expenditures, suggesting that consumers are spending less enthusiastically.

Historically, it has been challenging for the Fed to reduce inflation without causing a significant economic downturn. Slower demand is required to force companies to stop raising prices. Adjusting Fed policy is a complex task since it is a blunt tool.

There are still potential risks, such as a potential government shutdown, auto industry strikes, and elevated crude oil prices that could impact inflation. Despite these risks, central bankers are optimistic about achieving a “soft landing” by cooling price increases without harming economic growth.

Austan Goolsbee, the president of the Federal Reserve Bank of Chicago, expressed confidence that inflation will be brought back to the Fed’s target, and emphasized the rare opportunity for the Fed to combat inflation without causing a recession.