US inflation rise to 3.2% highlights ‘last mile’ challenge for Fed

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US inflation increased unexpectedly to 3.2 per cent last month, in data set to be scrutinised by the US Federal Reserve as it decides when to reduce interest rates.

Economists polled by Bloomberg had expected the annual rise in consumer prices to remain unchanged from January’s rate of 3.1 per cent.

The consumer price inflation numbers are expected to play an important part in the Fed’s meeting next week when rate-setters are due to vote on whether to cut rates from their 23-year high of between 5.25 and 5.5 per cent.

The March 20 meeting will also detail how many cuts the Fed is planning. At present, the central bank plans to reduce rates three times this year. Markets expect three or four cuts during the course of 2024.

Torsten Sløk, chief economist at Apollo Global Management, said the figures from the Bureau of Labor Statistics on Tuesday would keep pressure on the US central bank to keep borrowing costs higher for longer.

“Inflation has started to move sideways and remains well above the Fed’s 2 per cent inflation target,” he said.

Services-related prices were one of the big drivers of the 3.2 per cent annual rise in headline inflation for last month, with motor insurance, health costs and other services all showing big increases.

“These inflation numbers presage a rockier period ahead for the Fed,” said Eswar Prasad, a professor at Cornell University. “Although the US economy has held up well so far, there is a risk that persistent inflation and the Fed’s response to it might turn a soft landing scenario into a soft stagflation one.” 

However, US stock futures extended gains after the data release.

Contracts tracking the S&P 500 index rose 0.5 per cent, while those tracking the technology-heavy Nasdaq 100 increased by 0.7 per cent.

Government bonds were subdued, with the policy-sensitive two-year Treasury yield and the benchmark 10-year yield both broadly flat at 4.55 per cent and 4.11 per cent respectively.

The dollar was unmoved on the day after trimming an earlier advance.

“It’s surprising that we haven’t seen more of a negative reaction,” said Tim Murray at T Rowe Price, an asset manager. “This last mile of inflation — getting from 3 per cent to 2 per cent — is going to be really hard. Much harder than getting from 9 to 3 per cent.”

He added that hope for May rate cuts “keeps getting pushed back . . . You have to wonder even how many cuts we’re ultimately going to get.”

Tuesday’s figures showed core inflation, which excludes changes in food and energy costs, at 3.8 per cent compared with 3.9 per cent in January. Economists had expected a fall in the metric, which is seen as a better measure of underlying price pressures, to 3.7 per cent.

The month-on-month headline figure for consumer price inflation rose from 0.3 per cent in January to 0.4 per cent last month.

The Fed targets an alternative measure of inflation — personal consumption expenditures. However, with the February PCE figure not out until after the March 20 vote, the CPI data is expected to influence rate-setters’ deliberations.

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