Inflation drops to 3.1 percent; Fed unlikely to raise interest rates

Inflation came down in 2023 much faster than anyone expected, sealing expectations that the Federal Reserve won’t raise interest rates this week and shrinking the chances that the economy is headed for a recession.

A year after prices soared to four-decade highs, inflation for all sorts of goods and services has fallen considerably. The shift still leaves actual prices for eggs, bread, rent and other basics higher than just a few years ago. But costs aren’t rising at such a dizzying, rapid clip - bringing stability and predictability to household budgets and the economy at large.

Fresh data from the Bureau of Labor Statistics on Tuesday showed prices rose 3.1 percent in November over the year before, and about 0.1 percent compared to October. That’s still higher than normal, but a vast improvement since the consumer price index peaked at 9.1 percent in June 2022.

Major stock indexes were muted on the report, staying flat shortly after Tuesday’s open.

A steady stream of encouraging news over the past few months all but guarantees that the Federal Reserve will leave rates unchanged when officials gather for their final policy meeting of the year on Tuesday and Wednesday. Since they started hoisting rates in the spring of 2022 as inflation spiked, central bankers were often in catch-up mode, scrambling to get borrowing costs high enough to meaningfully slow the economy. But officials have charted a different path since late summer, pausing rate hikes to see how the economy responds to everything they have done so far.

The answer: The economy has stayed remarkably resilient through high rates, prompting forecasters to slash expectations for a recession. Asked Tuesday whether the United States had averted a downturn and achieved what’s known as a “soft landing,” Treasury Secretary Janet L. Yellen gave a hopeful prediction.

“I believe that’s the path we’re on,” she said at the Wall Street Journal CEO Council Summit.

The big questions now are whether the Fed has indeed reached the end of its aggressive rate-hike campaign - and whether the central bank will cut rates in 2024. The markets are eager for any hints, which could come during Federal Reserve Chair Jerome H. Powell’s news conference on Wednesday afternoon, after the Fed’s two-day meeting.

There were no surprises in the inflation report, and officials have long said that they can only make informed decisions based on months of data. Michael Strain, director of economic policy studies at the conservative American Enterprise Institute, said it was important not to “wildly react in one way or another.”

“I don’t think this really updates our information all that much one way or the other, which is fine,” Strain said. “My view of the situation is not all that much different today than it was yesterday, which means calls for popping the champagne are premature.”

Inflation in November was largely driven by housing costs, continuing a persistent trend. Rent was up 0.5 percent compared to October - showing no improvement over the previous few months. Medical care and car insurance were also up.

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For over a year, housing costs have played a major role in keeping overall inflation high. And while there are some signs that rents have cooled from their pandemic peaks, experts say it will take some time before the shift shows up in federal data.

“We’re all waiting for the same thing, which is that lag in rents,” said Joe Brusuelas, chief economist at RSM. “That’ll be springtime, maybe. But the tone and tenor of this report is inflation continues to abate, creating the conditions for when the Fed can move away from rate hikes, and be considering cuts.”

Gas and energy prices - which surged after Russia’s invasion of Ukraine in 2022 - saw some of the largest drops. Gas prices fell 6 percent in November, following a 5 percent drop in October. The overall energy index, which also includes commodities like fuel oil and electricity, fell 2.3 percent in November, keeping momentum going from the previous month.

Officials also keep a close eye on a narrower measure of inflation known as “core,” which strips out volatile categories like food and energy to refine policymakers’ sense of where inflation is sticking. That measure rose 0.3 percent in November, up a smidgen from October but still trending in the direction the Fed wants to see.

But officials are still many steps short of declaring victory, and they are mindful that higher-than-normal costs weigh heavily on households’ budgets. In a statement, President Biden said that despite recent progress on inflation, “I know many Americans still find too many things unaffordable.” He touted the administration’s moves to bring down prescription drug costs and insurance premiums, and eliminate junk fees - all steps that are outside the Fed’s narrow remit.

“And now that our actions have helped rebuild supply chains and brought down input costs, I’m calling on large corporations to pass along the savings to consumers,” Biden said.

Fed leaders consistently say any number of threats, including wars abroad or China’s economic slowdown, could send inflation in the United States back up. Officials warn that failing to finish the job could jeopardize the economy even more down the line.

Before announcing rate cuts, central bankers will have to explain how they feel comfortable lowering borrowing costs, especially if inflation hasn’t quite hit the Fed’s 2 percent target. Instead of offering a clear timeline this week, Powell will probably caution that “things are looking good, but we’re waiting to see irrefutable evidence that the momentum is still with us,” said Wendy Edelberg, director of the Hamilton Project and a senior fellow in economic studies at the Brookings Institution.

Plus, no one is entirely sure what it will take to snuff out the sources of inflation that don’t come from gas prices or bungled supply chains. Officials expect some relief on the housing front, with roughly 1 million multifamily rental units slated to become available later this year and next. Higher rates are usually expected to lower housing prices, too, by tamping down demand for home purchases as mortgages get more expensive.

But in yet another twist of the pandemic recovery, large parts of the economy aren’t responding to high interest rates as Econ 101 would suggest. The Fed’s benchmark interest rate, known as the federal funds rate, stands between 5.25 and 5.5 percent - the highest level in 22 years.

Economists widely expected the steep run-up in rates would cause a recession. Instead, key pillars of the economy are roaring.

Crucially, consumer spending continues to propel the economy forward. Employers are still hiring, with the unemployment rate at a hot 3.7 percent. And in recent months, Powell has pointed to groups that just aren’t that hampered by high borrowing costs, like homeowners who bought homes when mortgage rates were still low, or businesses that termed out their debt and now aren’t feeling tighter financial conditions.

“It really is a story of much stronger demand,” Powell said in October. “There may be some ways the economy is less affected by interest rates. It’s hard to know precisely.”