Cooling U.S. inflation builds case for September slowdown in Fed rate hikes

May 27 (Reuters) – Evidence U.S. inflation is cooling will not budge Federal Reserve policymakers from half-point interest rate hikes planned for upcoming meetings in June and July, but may prompt a shift to smaller rate hikes come September if the trend continues.

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

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

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

The core PCE index, which strips out food and energy prices to give a clearer read of more persistent price pressures, rose 4.9% – again, far too high for comfort, but marking a second straight month of moderation from what may have been a peak in February of 5.3%.

The decline in core inflation is particularly good news for the central bank, along with fresh evidence that household spending continues to grow despite still fast-rising prices. 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 are seeing movement in the right direction,” Nationwide Economist Dan Hadden wrote in a note. As long as inflation continues to stabilize or moderate, “it will likely give the (Fed) more flexibility later this year.”

The Fed has lifted interest rates three-quarters of a percentage point so far this year, and most policymakers expect to deliver a couple more half-a-percentage-point rate hikes, recent public comments and a record of their May meeting show.

That would bring overnight bank-to-bank borrowing costs to a range of 1.75%-2% by the end of July. Anticipation of those rate hikes already appears to be taking a bite out of demand in the housing market, where prices have soared but sharp increases in mortgage rates helped push down home sales for a sixth straight month in April.

That softening suggests price increases will also moderate in months ahead and, says Comerica’s Bill Adams, will start to show up in slower inflation readings late this year or in early 2023.

Already at the Fed’s May meeting, “a number” of policymakers thought “monthly data might suggest that overall price pressures may no longer be worsening.”

The broad hope at the Fed is to get through this era of price shocks and uncertainty with, at worst, a slowdown in the pace of growth, rather than an out-and-out recession that causes a dramatic rise in unemployment.

“Amid rising pessimism about the state of the US consumer, today’s report provides some reassurance that the main pillar of the economy is still standing strong in the face of historic inflation and rising borrowing costs,” Oxford Economics’ Lydia Boussour wrote on Friday.

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