A Key Inflation Measure Cooled in December

A measure of inflation closely watched by the Federal Reserve continued to cool in December, the latest sign that price increases are coming back under control even as growth remains solid and the labor market healthy. In particularly positive news, a key gauge of price increases dipped below 3 percent for the first time since early 2021.

The Personal Consumption Expenditures price index picked up 2.6 percent last month compared to a year earlier. That was in line with what economists had forecast and matched the November reading.

But after stripping out food and fuel costs, which can move around from month to month, a “core” price index climbed by 2.9 percent from December 2022. That followed a 3.2 percent November reading, and was the coolest since March 2021.

Fed officials aim for 2 percent price increases, so today’s inflation remains elevated. Still, it is much lower than its roughly 7 percent peak in 2022. In their latest economic projections, central bankers predicted that inflation would cool to 2.4 percent by the end of the year.

As inflation progresses back to target, policymakers have been able to dial back their campaign to slow down the economy. Fed officials have raised interest rates to a range of 5.25 to 5.5 percent, up sharply from near-zero as recently as early 2022. But they have held borrowing costs steady at that level since July — forgoing a final rate increase that they had previously predicted — and have signaled that they could cut interest rates several times this year.

Officials are trying to complete the process of setting the economy down gently, without inflicting serious economic pain, in what is often called a “soft landing.”

“The punchline here is that the data is still consistent with a relatively soft landing, at least for now,” said Gennadiy Goldberg, head of U.S. rates strategy at TD Securities. Between strong growth and milder inflation, “they’re getting the best of both worlds.”

Now, investors are watching closely to see when, and how much, policymakers will lower borrowing costs.

Fed officials are toeing a delicate line as they decide what to do next. Keeping rates too high for too long could risk cooling the economy more than is strictly necessary. But lowering them prematurely could allow the economy to reheat, making it harder to bring inflation fully under control.

Fed policymakers meet next week, and officials are expected to leave interest rates unchanged when that gathering concludes on Jan. 31. Still, markets will closely watch a news conference with Jerome H. Powell, the Fed chair, for any hint at what might come next.

Mr. Powell may be offer insight into how the Fed is thinking about the interplay between growth and inflation. The economy is still growing at a solid pace and unemployment is very low, which many economic models would suggest could cause inflation to pick back up.

Friday’s report showed that consumption climbed more than economists had expected in December, for instance, especially after adjusting for cool inflation.

But so far, price increases have continued to moderate despite the momentum. That has come as the labor market balances out, supply chain problems tied to the pandemic clear and rent increases fall toward more normal levels.

Given that, officials have been more focused on actual price figures in recent months as they talked about the policy outlook. But they still take growth into account when they are thinking about policy.

Rapid growth is “only a problem insofar as it makes it more difficult for us to achieve our goals,” Mr. Powell said in December. “It probably will place some upward pressure on inflation. That could mean that it takes longer to get to 2 percent inflation. That could mean we need to keep rates higher for longer.”