The Consumer Price Index (CPI) report for December has emerged as anticipated, displaying a complex picture of inflation in the United States. Analysts had already widely predicted that this report would be “muddy”—and it didn’t fail to deliver on that front. The Federal Reserve, facing rising inflationary pressures, has resumed expanding its balance sheet, creating further uncertainty regarding interest rate adjustments.
Measured year-over-year, the annual core CPI held constant at 2.6 percent in December. Core CPI prices rose at just 0.2 percent over the prior month. The headline annual CPI rate was unchanged at 2.7 percent. All prices rose 0.3 percent over the last month, right in line with expectations. Food prices skyrocketed by even more during this time—up by 0.7 percent. Energy prices still rose 0.3 percent despite the drop in gasoline prices by 0.4 percent.
Understanding the December CPI Details
According to the CPI report, shelter costs increased by 0.4 percent m/m as they continue to add upward pressure to the inflationary environment. Further, service inflation rose by 0.3 percent, an indication of price inflation that seems completely divorced from tariff-induced sectoral pressures. Inflation wasn’t consistent across all sectors, with used cars and trucks seeing the steepest price decline, decreasing by 1.1 percent.
Though there are some glimmers of stability even in core readings, inflation is still well above the Federal Reserve’s professed target. The central bank’s renewed expansion of its balance sheet suggests a perception of increasing inflationary pressures, which complicates their ability to cut interest rates later this month.
“We’ve seen this movie before — inflation isn’t reheating, but it remains above target. There’s still only modest pass-through from tariffs, but housing affordability isn’t thawing. Today’s inflation report doesn’t give the Fed what it needs to cut interest rates later this month.” – An unnamed economic analyst
Implications for the Federal Reserve
The Federal Reserve, in turn, finds itself in the unfortunate position of having to discern the meaning behind these contradictory signals as it pursues its monetarist agenda. Today’s CPI report does not lead to the sort of clarity that would justify immediate interest rate cuts. Inflation is still well above the target, showing little sign of easing. Consequently, the Fed is presented with a pretty profound dilemma right now: to hold the line on interest rates or not.
Morgan Stanley’s chief economic strategist Ellen Zentner commented on the recent trends in core CPI readings:
“However, over the last six readings (with no October data), core CPI has increased by 0.2, 0.3, 0.3, 0.2, 0.2, and 0.2 percent, annualizing to 2.8 percent. Core CPI has been mired in this range for well over a year.”
In reading through Zentner’s observations, it is easy to assume that with core CPI readings running between 3-4% as the new normal, we are out of the woods.
Reevaluating CPI Measurement Methods
Debate about whether the CPI is a valid measure of inflation has recently seen a resurgence. Critics have pointed out that the government revised the CPI formula in the 1990s, which some argue has led to an understatement of actual price increases. Some commentators are comparing these new figures to a re-calculation done with the old 1970s formula. This leads them to propose that inflation is almost twice what the official figures state.
This divergence begs the question, how do policymakers understand this economic indicator and based on that understanding make life altering decisions for millions of Americans. Given the inherent complexity of measuring inflation, stakeholders should weigh competing factors and approaches in their analyses.