Inflation eases in January but economists project a bumpy road ahead to reach the Federal Reserve's 2% target

Inflation may have peaked but will take the slow path to the Fed's 2% target

On a monthly basis, inflation rose 0.5%, the sharpest one-month gain since last October, according to the Bureau of Labor Statistics. (iStock)

The annual level of inflation registered the smallest 12-month increase since October 2021, signaling that inflation has likely peaked, according to the latest report from the Bureau of Labor Statistics (BLS).

The Consumer Price Index (CPI), a measure of inflation, rose 6.4% year-over-year in January, a slight slowdown from the 6.5% increase in December. On a monthly basis, inflation rose 0.5%, the sharpest one-month gain since last June, the BLS said.  

Overall, prices for shelter, food, gas, and natural gas increased in January, with shelter accounting for nearly half of the monthly all items increase. 

Gas rose 2.4% from the previous month after registering several months of decline. The shelter index increased 7.9% annually, rising 0.7% in January and accounted for nearly 60% of the total increase in all items, less food and energy, according to the BLS.

"Inflation may have peaked, but it's not showing signs rapidly returning to the Fed's long-run goal of 2%," John Leer, Morning Consult's chief economist, said in a statement. "Shelter's contribution to inflation is likely to slow in the coming months, but there remain upside risks to durable goods prices. 

"Despite all of the challenges facing the U.S. consumer, demand remains too strong relative to supply. The fight against inflation is far from over."

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Fed faces bumpy road to reach 2% inflation target

Although the disinflationary process had begun, it still had a long way to go, Federal Reserve Chair Jerome Powell said at a recent event hosted by The Economic Club of Washington, D.C.  

"Our message is that this process is likely to take quite a bit of time," Powell said. "It's not going to be smooth, it's probably going to be bumpy and we think we will need to do further rate increases and hold policy at a restrictive stance for a period of time."

The Fed began easing on interest rate hikes and raised rates by 25 basis points at its latest meeting. That was preceded by a 50 basis points rate hike in December

The slowdown in interest rate hikes has primarily been interpreted as a sign that the worst of inflation may be behind the market. However, January's CPI and a surprisingly resilient jobs report for last month show the challenges the Fed faces to reach its 2% inflation target.

"While the strong employment market is good news for consumers, persistently high inflation is not," Tracy Bell, the director of equity strategies at First Horizon Advisors, said. "There has been some relief for consumers with respect to the prices of some goods, such as used cars, but overall inflation is only making slow progress towards the Fed's 2% goal. 

"This is particularly pronounced within services prices where the job market is also the tightest," Bell continued. "The trick for policymakers is threading the needle of slowing inflation without slowing the employment backdrop too much."

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Recession could still be on the cards

The tight labor market is likely to make the road back to 2% inflation longer than many had hoped, according to Jim Baird, the chief investment officer at Plante Moran Financial Advisors.

Baird said that announcements of job cuts in past months are a good sign that the labor market is headed in the direction. However, for the Fed to reach its target, it would need to see more slack in the labor market, which would require an uptick in the unemployment rate. 

"Although the full impact of already implemented rate hikes hasn't been felt and should continue to put the brakes on the economy in the coming months, there's little reason for the Fed to pause yet," Baird said in a statement. "The question is whether policymakers will feel compelled to go even further than their current forecasts suggest and, in doing so, potentially slamming the door on any soft-landing scenario."  

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