By Ann Sapphire and Lindsay Dunsmuir
(Reuters) – Federal Reserve policymakers are finally seeing some sustained progress in curbing high inflation, cementing their plan to hike interest rates by a quarter of a point next week, with traders betting they will end their hike campaign in March.
The Federal Reserve’s favorite index of inflation, the personal consumption expenditure (PCE) index, rose 5.0% year over year in December, slower than November’s 12-month gain of 5.5%, the government said on Thursday Friday reported lowest since September 2021.
Core PCE, which the Fed uses to gauge the underlying dynamics of inflation as it strips out volatile components, rose 4.4% year-on-year, the slowest pace since October 2021. In the most recent three-month moving average, it rose by around 3.2% on an annualized basis.
This slowdown has traders betting that the Fed will soon end its most aggressive monetary tightening since the 1980s, aimed at dampening demand across the economy to quell inflation, which rose to a 40-year high last year is to bring it back to its 2% target interest rate.
“The Fed may rightly slow the pace of rate hikes next week as inflation cools,” said Jeffrey Roach, chief economist at LPL Financial.
Futures linked to the Fed’s policy rate almost certainly price in that the central bank will hike its policy rate to 4.5%-4.75% at the end of its Jan. 31-4.75 meeting. 1 session, up 4.5% from now 4.25%, with another quarter point hike priced in for March.
Other price data are also adjusted. A survey released later on Friday showed US consumer inflation prospects for the coming year slipped to a level not seen since April 2021 at 4.0%. The five-year inflation outlook also fell from 3.0% to 2.9%.
DOUBTS ABOUT HOLDING RATES
Fed policymakers have signaled they expect interest rates to eventually move a bit higher – to just over 5% – and have warned they do not expect rate cuts this year to ensure they end the fight against inflation for good to win.
The story goes on
But traders see only a one-in-three chance of another quarter-point rise after March, and after the government report, which also showed consumers cutting spending, increased their bets on rate cuts beginning as early as September.
Consumer spending accounts for more than two-thirds of economic activity, so signs of slowing economic growth, with manufacturing also in the early stages of a downturn, increase the risk of a recession in the second half of the year.
The central bank, while claiming interest rates will be kept at peak levels for some time, will cave in if inflation falls further while the economy softens too much under the weight of monetary tightening.
“With higher interest rates now clearly weighing heavily on demand, we expect core inflation to weaken further this year, eventually prompting the Fed to start cutting rates later this year,” said Paul Ashworth, chief economist for North America at Capital Economics.
(Reporting by Ann Saphir and Lindsay Dunsmuir; Editing by Raissa Kasolowsky, William Maclean and Andrea Ricci)
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