Consumer Price Index: Inflation expected to dip below 3% in January

The upcoming release of January's Consumer Price Index (CPI) on Tuesday will have significant implications for investors and the Federal Reserve's upcoming interest rate decision. 

According to estimates from Bloomberg, the report is expected to show a headline inflation rate of 2.9%, marking a notable deceleration from December's 3.4% annual gain. This anticipated figure would represent the lowest annual inflation rate in approximately three years, marking the first time it has dropped below 3% since March 2021.

Anticipated data

The projection suggests that consumer prices are expected to increase by 0.2% from the previous month, a figure in line with December's recently revised monthly rise. Furthermore, on a "core" basis, which excludes the more volatile costs of food and gas, prices are expected to have risen by 3.7% over the previous year—a slowdown from the 3.9% annual increase seen in December. The monthly core prices are expected to have climbed 0.3%, remaining unchanged from the prior month.

Economic analysis

Bank of America (BofA) has emphasized that core inflation has remained particularly resilient, with high shelter prices and "volatile" categories such as used cars, transportation services, and lodging away from home playing key roles. However, BofA economists Stephen Juneau and Michael Gapen anticipate that shelter inflation will moderate over the year due to disinflation in asking rent inflation.

BofA's expectations

BofA anticipates that services will be bolstered by larger price increases in transportation services and lodging away from home as the demand for travel has shown strong early-year performance. Additionally, the bank notes that used car prices are expected to decrease by approximately 1.8% on a month-over-month basis.

Federal Reserve's considerations

The sustained annual inflation above the Federal Reserve's 2% target has sparked discussions about potential interest rate adjustments. However, Fed Chair Jerome Powell has tempered expectations, indicating that a March rate cut is unlikely. Current market trends indicate an almost 85% probability of the Federal Reserve maintaining rates in March, with expectations of a rate cut at the May meeting. BofA aligns with this outlook, predicting the first rate cut in June.

Analysts' views

Several Fed officials, including Cleveland Fed President Loretta Mester and Minneapolis Fed President Neel Kashkari, have expressed caution regarding the timing of potential rate cuts, emphasizing the need for sustained evidence of inflation returning to the 2% target. The broader market sentiment expects the Fed to wait until later in the year to implement rate cuts.

In light of falling inflation, the Federal Reserve faces a delicate balancing act as it weighs the potential adjustments to interest rates. This could have significant implications for market dynamics and economic growth. Analysts anticipate that the upcoming CPI release and subsequent data will continue to shape the Federal Reserve's policy decisions in the coming months.