Inflation in the US eased in October as a measure of underlying consumer price pressures retreated from historic highs, sparking a rally on Wall Street as expectations firmed the Federal Reserve will downshift the pace of its rate increases next month.
The annual pace of the “headline” consumer price index slowed to its lowest since January, but traders zeroed in on signs of easing inflationary pressures in the “core” reading and its potential implications for monetary policy.
Core CPI, which excludes food and energy, rose 0.3 per cent from the previous month, in figures released on Thursday. That was well below the 0.6 per cent pace recorded in September and the 0.5 per cent increase forecast by economists.
Compared with the same time last year, core inflation is up 6.3 per cent, pulling back from the previous month’s four-decade high of 6.6 per cent.
Core measures of inflation are viewed by the Fed and economists as the best metric for the trajectory of inflation going forward.
The annual pace of the headline CPI, which includes volatile items such as food and energy, slowed to 7.7 per cent in October, down from 8.2 per cent the previous month. That was the lowest level since January and below the 8 per cent advance economists expected. Month on month, the index jumped 0.4 per cent, less than the consensus forecast of 0.6 per cent.
The S&P 500 surged as much as 4.4 per cent in morning trading on Wall Street following the data, putting the benchmark index on course for its biggest daily jump since April 2020. The two-year Treasury yield, which is particularly sensitive to interest rate expectations, dropped 0.33 percentage points to 4.3 per cent, its lowest level since late October.
Investors in the futures market increased bets that the Fed would lift interest rates by 0.5 percentage points in December, rather than 0.75 percentage points.
“The hope has been we would see a cresting in the inflationary pressures, and today’s report gave us some evidence of that,” said Joe Davis, global chief economist at Vanguard.
Prices for used vehicles extended a multi-month decline, dropping 2.4 per cent in October. That was partially offset by a 0.8 per cent rise in housing-related costs. Compared with a year ago, the shelter component of the CPI is up 6.9 per cent and, in October, contributed to half the monthly inflation increase.
Once energy-related items were stripped out, prices for services rose 0.5 per cent, down from 0.8 per cent in September, as medical care costs and airline fares declined.
The inflation data, released by the Bureau of Labor Statistics, came on the heels of unexpectedly tight midterm elections that left the battle for control of Congress still hanging in the balance.
High inflation has dogged Joe Biden’s administration for the bulk of his presidential term, igniting fears of a pronounced economic downturn at some point next year as the Fed steps up its efforts to get price pressures under control.
Jay Powell, Fed chair, signalled last week that the central bank would probably need to lift interest rates to a higher level this tightening cycle than initially expected as it grapples with an economy that has proven resilient in the face of rapidly rising interest rates.
Most economists now expect the so-called terminal rate to close in on 5 per cent next year, well above the 4.6 per cent projected by most Fed officials as recently as September.
“You only bring down inflation sustainably when the interest rate is above the pace of trend inflation. Full stop,” said Davis, who also expects the fed funds rate to eventually hover around 5 per cent.
To get there, officials have begun to lay the groundwork for smaller rate rises, having increased rates by 0.75 percentage points at each of its four previous meetings.
At the press conference that followed the November gathering, at which the Fed lifted its benchmark policy rate to a target range of between 3.75 per cent and 4 per cent, Powell said the central bank could scale back the pace of increases at the December meeting or the one after that.
While officials have previously said they need to see a slowdown in the inflation data before they can alter course, they are now more directly taking into account how much rates have already risen this year and the fact that it takes time for those adjustments to affect the economy. As a result, less emphasis is placed on each subsequent CPI report.
“We do need to see inflation coming down decisively and good evidence of that would be a series of down monthly readings,” Powell said last week. “But I’ve never thought of that as the appropriate test for slowing the pace of increases or for identifying the appropriately restrictive level that we’re aiming for.”
He has repeatedly warned that the higher rates need to rise and the longer they stay at a level that is constraining economic activity, the greater the odds of the economy tipping into a recession. Most economists expect a contraction next year, with the unemployment rate rising substantially above its current 3.7 per cent level.