In February, inflation rose in line with expectations according to the personal consumption expenditures price index excluding food and energy. The index increased by 2.8% on a 12-month basis and 0.3% from the previous month. Both numbers matched estimates, with the headline PCE reading showing a 0.3% increase for the month and 2.5% on a 12-month basis when including volatile food and energy costs. The Federal Reserve considers core inflation to be a better gauge of long-term inflation pressures and targets a 2% annual inflation rate.
The stock and bond markets were closed for the Good Friday holiday, but when they reopen on Monday, analysts expect the Fed to stay on hold in regards to interest rate cuts. Despite the slightly higher than desired inflation figures, market participants are focusing more on labor market indicators to determine the potential for rate cuts in the future. Rising energy costs contributed to the increase in inflation, with the goods side experiencing a higher increase compared to services. Consumer spending also saw a significant increase of 0.8% on the month, which could further add to inflation pressures.
The release of the inflation data comes shortly after the Federal Reserve decided to keep its benchmark short-term borrowing rate unchanged and indicated that it has not seen enough progress on inflation to consider cutting rates. In their quarterly rate projections, members of the Federal Open Market Committee pointed to three quarter-percentage point cuts this year and in 2025. Market expectations align with the FOMC projections, with three cuts expected and pricing in line with the FedWatch measure of futures market action.
Despite the increase in inflation, the Fed is expected to remain on hold when it releases its decision on May 1 and may start cutting rates at the June 11-12 meeting. The Fed targets a 2% annual inflation rate and core PCE inflation has not been below that level in three years. The inflation pressures were mainly driven by rising energy costs and the goods side, with notable contributions from international travel services, air transportation, and financial services. The impact of these inflation figures on the Fed’s decision-making process will be closely watched by market participants in the coming weeks.
