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Year-over-year U.S. inflation fell to its weakest rate in more than a year in December, a further sign that inflationary pressures have peaked amid a historic tightening of monetary policy by the Federal Reserve.
The U.S. Bureau of Labor Statistics reported on Wednesday that the consumer price index (CPI) rose 6.5% in December from a year earlier, the sixth consecutive month of narrowing gains.
The gain, while still near multi-decade highs, was already the slowest since October 2021 and markedly down from 9.1% in June last year. In December last year, the CPI fell by 0.1% month-on-month.
The closely watched “core” CPI rose 0.3% in December from the previous month and 5.7% from a year earlier. The “core” CPI, which strips out volatile food and energy prices, is seen as the best indicator of the trajectory of inflation.
Fed officials are closely watching the latest inflation data to gauge how hard they want to further rein in the U.S. economy. The U.S. central bank, which had cut interest rates to 0.5 percentage points last month after raising rates four times in a row by 0.75 percentage points, is considering whether it can return to a more typical pace of 0.25 percentage point hikes at its next policy meeting.
The Fed decided in December to slow down the pace of rate hikes after it had already hiked aggressively in a short period of time. The U.S. central bank also takes into account the fact that changes in monetary policy take time to have an impact on economic activity.
The decision follows a string of better-than-expected inflation data that appeared to point to a more pronounced ebb in consumer demand. This has coincided with an easing of supply chain bottlenecks, helping to drive down prices for energy as well as everyday items such as cars, appliances and clothing.
The Fed is keeping a close eye on service sector inflation — which, officials say, is closely tied to rising labor markets and wages as employers try to overcome severe staff shortages — after stripping out energy, food and housing-related costs. Wage growth has eased from its peak, but job growth remains strong and the unemployment rate remains near historic lows.
The fear is that service-related price pressures will be difficult to eradicate, requiring a period of very low growth and higher unemployment. Since meeting in December, Fed officials have delivered a consistent message that the federal funds rate will likely need to rise above 5 percent and stay there through 2023 to keep inflation in check. The target range for the federal funds rate is currently 4.25% to 4.5%.
Judging from the current market pricing, the market does not agree with such a forecast, but believes that the Fed will raise the policy rate to just below 5% and will start to cut interest rates before the end of the year.