Inflation rises higher than expected, further obscuring the timeline on the Fed’s interest rate cuts

Inflation increased again in January, driven by a continued uptick in prices for food, housing and other services, according to the Consumer Price Index (CPI) released by the Bureau of Labor Statistics (BLS). 

On an annual basis, prices rose 3.1% in January, less than the 3.4% growth last month but above the sub-3% growth economists had expected. On a monthly basis, prices increased 0.3 percentage points in January after having increased 0.2 points the previous month. Core inflation, which excludes more volatile food and energy prices, increased 0.4 percentage points, slightly above the 0.3 points increase last month. On an annual basis, core CPI rose 3.9%.

Shelter costs continue to waive heavily on consumer expenses, contributing to over two-thirds of the monthly increase. Food prices also rose 0.4 percentage points in January, offset by a 0.9-point drop in energy prices mainly because gas prices have declined since December’s CPI. 

January’s CPI reading shows that inflation has remained above 3% for months now and core price growth appears to be stabilizing at an even higher rate, further obscuring the Federal Reserve’s timeline for slashing interest rates. 

The Fed anticipates several interest rate cuts this year but has yet to set a timeline for how soon or far it will go. That will depend on how fast inflation returns close to that 2% target rate or if the Fed senses that the U.S. economy is headed into a recession. Fed officials have predicted at least three rate cuts this year, with interest rates expected to tick down to 4.6%, according to the central bank’s updated economic forecasts in its Summary of Economic Projections (SEP).  

“Today’s hotter-than-expected inflation reading emphasizes the persistent upside risks that continue to percolate in the U.S. economy, potentially challenging the Fed’s ability to achieve and maintain its 2% price growth target,” Morning Consult Senior Economist Kayla Bruun said in a statement.

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Rates won’t budge in time for spring homebuying

The chance of an interest rate cut coming in time for the spring homebuying season has dimmed. January’s inflation reading likely confirms the Fed’s wait-and-see approach, according to Realtor.com Chief Economist Danielle Hale. The longer the Fed delays dialing back rates, the longer it will take for mortgage rates to take a meaningful dip. 

Mortgage rates have held steadfast in the mid-six range after dropping more than a percentage-point drop in mortgage rates since late October. While the decrease has helped some buyers with affordability, a further drop would help open the market to more buyers. 

“For the housing market, today’s data means that mortgage rates are likely to hang on to the narrow range they’ve occupied since late December, while likely moving toward the upper end of that range,” Hale said in a statement. “The welcome stability of rates in recent weeks has offered some relief for home shoppers, a sharp contrast to the volatility of 2023, and should support more home sales.”

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Rate cuts won’t come till later in the year

Sticky inflation paired with solid economic data gives the Fed more room to wait and investors have been increasingly looking past March to the next Fed meeting in May as a potential launch point for rate cuts.

“While there is a softening in rents, there are still some stubbornly high prices, which is balancing the nation’s economy on its path to a so-called soft landing,” CoreLogic Chief Economist Selma Hepp said. “Overall, the nation’s economy remains strong, so don’t expect an interest rate cut this half of the year unless prices take a larger, downward trajectory.”

The timing of when the Fed begins to dial back rates and by how much will depend on other expectations being met – a moderation in growth, further loosening in labor market conditions, and more convincing evidence that inflation has meaningfully eased, according to Jim Baird, Plante Moran Financial Advisors chief investment officer.    

“A reacceleration in inflation may not lead the Fed to reverse course and raise its policy rate further, but it could forestall anticipated cuts,” Baird said in a statement. “Inflation remains a risk that is firmly within the Fed’s focus. 

“Policymakers fear cutting rates too soon only to see an inflation resurgence that would force them to reverse course and tighten further, damaging their credibility in the process,” Baird continued. “The other risk that can’t be overlooked is that policymakers keep rates too tight for too long – ultimately besting inflation but taking the economy into recession in the process.” 

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