Inflation eased for a seventh month straight in January, but interest rates will keep rising as the Fed works harder to root stubbornly high prices out of the economy.
The report showed January prices rose 0.5 percent in comparison with the previous month, a bump from the 0.1 percent rise in the December report, and a less-than-encouraging sign for economists and policymakers who argue that progress is best measured month by month.
The latest report underscored a key challenge facing the Fed — and the overall economy. Prices are easing, a welcome reversal after 2022’s eye-popping inflation rates. But finishing the job requires targeting some of the most persistent sources of inflation and keeping the pressure on. No part of the Fed’s job until now has been easy, and the central bank had to scramble to get inflation down from 40-year highs last year. But price increases are still abnormally high, and getting them down to sustainable levels may require a level of pain that has so far been avoided.
“We’ve seen inflation come down. That’s the good news,” said Douglas Holtz-Eakin, former head of the Congressional Budget Office and the president of the conservative American Action Forum. “The bad news is there’s a lot of work left. There are parts of the economy, like the goods sector, where [the Fed] can think ‘we’ve done our job.’ The Fed can’t do that. They’re going to have to keep going.”
The markets were muted for much of the day, but the Dow Jones industrial average closed down 156.6 points, or 0.46 percent. The S&P 500 was essentially flat, falling 0.03 percent, and the Nasdaq rose 0.57 percent.
Housing costs were by far the largest contributor, accounting for nearly half of the monthly increase. Fed officials and economists expect rent inflation eventually to fall as costs for new leases cool off. But that has not happened on a significant scale yet. Rent in January was up 0.7 percent over the month in comparison with 0.8 percent in the previous report. It was also up 8.6 percent from the year before.
Categories including food, gasoline and natural gas also drove average prices higher. The food index in January rose 0.5 percent over December’s. Four of the six major grocery store categories increased over the month. Eggs, in particular, rose 8.5 percent in January, driven by shortages caused by the avian flu.
The energy index rose 2 percent over December, and the gasoline index increased 2.4 percent. Motor vehicle insurance also was up, along with the cost of clothing, household furnishings and recreation. New-car prices were up 0.2 percent.
There were a few bright notes: The cost of medical care fell 0.4 percent in January. Used cars and trucks also fell, by 1.9 percent, continuing a downward trend. Airfares fell 2.1 percent.
In a statement, President Biden said the seven-month streak in easing inflation was “delivering welcome breathing room for American families.” But even with a growing job market and other sources of economic strength, “there is still more work to do as we make this transition to more steady, stable growth, and there could be setbacks along the way," he said.
The past few months have bolstered confidence that encouraging inflation reports last fall really did represent the start of a trend and that the economy doesn’t appear to be barreling toward a recession — yet. The labor market in particular continues to show remarkable strength, with employers adding 517,000 jobs in January and the unemployment rate falling to 3.4 percent, a low not seen since May 1969.
But the Fed keeps repeating that its raising of interest rates to slow the economy is far from over, and there is much that could thwart its future efforts. A top concern is that the remaining sources of inflation — many of which are tied to the hot labor market and rising wages — will be difficult to tame. Last week, survey results from the University of Michigan also showed that consumers’ inflation expectations over the coming year increased, even if they’re feeling better about the economy as a whole.
In a Tuesday speech, Dallas Fed President Lorie Logan said that while there has been some progress on inflation, the question for monetary policy is “whether the progress will continue.” Supply chains can’t recover twice. It will take time for the slowing housing market to show up in rent costs. And services are showing few signs of improvement at all.
“Broad-based and persistent services inflation is not the result of special circumstances like supply-chain disruptions that will eventually go away," Logan said. “Rather, I see it as a symptom of an overheated economy, particularly a tight labor market, which will have to be brought into better balance for the overall inflation rate to return sustainably to 2 percent.”
The Fed has raised rates eight straight times in less than a year, most recently by a quarter of a percentage point, a slower pace than in nearly all of 2022. Fed leaders are planning for a few more increases of that scale, and then they’ll hold for a while and let high the higher rates take hold. The Fed’s base policy rate, known as the federal funds rate, sits between 4.5 and 4.75 percent, a level that is steep enough to slow the economy. The expectation is that rates will go past 5 percent and that officials won’t announce rate cuts until 2024, unless inflation comes down much faster than expected.
“The moral of the story is that inflation is not cooling as rapidly as the Fed would like, especially core inflation,” said Diane Swonk, the chief economist at KPMG, referring to a narrower inflation measure that strips out more-volatile sectors. “And that is something that is just going to affirm their commitment to continue raising rates at least two times.”
But only time and data will tell. So far, progress on inflation has largely come from improved supply chains, falling gas and energy prices, a cooling housing market and easing prices for consumer goods. Now the Fed is more focused on a narrow measure of inflation that looks at certain services, including education, medical care and hospitality, where wage pressures and labor shortages can keep pushing prices up.
In remarks at the Economic Club of Washington, D.C., last week, Federal Reserve Board Chair Jerome H. Powell said the lengthy process of getting inflation down is probably “not going to be smooth. It’s probably going to be bumpy.” He said that that expectation was confirmed by the unexpectedly hot January jobs report and that if the economic data “continued” to come in stronger than expected, “we would certainly raise rates more” than officials anticipate now.
Powell said goods prices are moving in the right direction, and housing costs should improve over the course of the year as rents on new leases stabilize. But there has been no progress in many services sectors that are key to reducing overall inflation.
“That’s going to take some time,” Powell said last week. “We need to be patient. We think we’re going to need to keep rates at a restrictive level for a period of time before that comes down.”
Interest rates work with a lag, and it will be months before the scope of last year’s large increases are felt. That could mean that pain for the labor market, or a significant drop in consumer spending, is still ahead. But for now, those key pillars of the economy remain intact: Mastercard is estimating that U.S. retail sales, apart from cars, rose 8.8 percent in January from a year earlier. And Goldman Sachs cut the probability that the U.S. economy will enter a recession in the next 12 months to 25 percent, down from 35 percent.
Sales have stayed strong at Forty Winks, a lingerie store in Cambridge, Mass. The small business had a busy start to the year and, on top of regular sales in January and over the summer, decided to add a pre-Valentine’s Day sale last week featuring 20 percent discounts in its physical stores and online, plus an in-store party with cookies and champagne. It was a hit.
Co-owner Rachel Wentworth said that there has been a big response to sales but that overall, she hasn’t felt a pullback at her nearly 13-year-old store. If anything, she’s looking to hire for some behind-the-scenes roles off the showroom floor to help the business grow.
“I always get nervous thinking, ‘Oh my god, we have to tighten our belts,’” Wentworth said. “But it doesn’t seem to translate to our business. I know it does translate to other businesses. But our numbers are really good.”