What Today’s Inflation Report Means For The Federal Reserve

With price pressures abating, the Federal Reserve could have more leeway to lower its key interest rate this year.

Today’s Consumer Price Index (CPI) report showed inflation was unchanged in May, a welcome development for households facing stubborn price pressures over the last few years. This will likely please officials at the Federal Reserve, who are set to announce an interest rate decision Wednesday afternoon.

Although Fed officials are widely expected to keep the key fed funds rate at its current 23-year high, the better-than-expected report could accelerate the timetable for rate cuts later this year, and ease concerns that inflation is flaring up again after a string of worse-than-expected consumer price reports in the first quarter.

The Fed’s campaign of anti-inflation interest rate hikes have pushed up borrowing costs on mortgages, credit cards, and other debt in an effort to stifle inflation by discouraging borrowing and spending. If lower inflation brings on lower interest rates sooner, it could relieve some pressure on people who have struggled to afford to buy a house or pay down credit card debt for example. 

When Will the Federal Reserve Cut Interest Rates?

The May report “keeps alive the prospect of the Fed starting to cut rates in September,” Kathy Bostjancic, chief economist at insurance company Nationwide wrote in a commentary. 

Before the report, traders were pricing in a 54.4% in September, according to the CME Group’s FedWatch tool, which forecasts rate movements based on fed funds futures trading data. Later in the morning, that number jumped to 72.7%.

As expectations rise in light of the inflation report, more scrutiny will be put on the Federal Reserve’s policy projections that will be released this afternoon.

“The materials and post-meeting press conference from the FOMC’s meeting later today will shed more light on how the Committee sees inflation evolving alongside its employment mandate,” wrote Wells Fargo economists Sarah House and Michael Pugliese.

Inflation Is Better But Still Too High For The Fed

When setting interest rates, Fed officials pay close attention to “core” inflation, which excludes prices for food and energy that tend to rise and fall for reasons that have nothing to do with broader inflation trends. Core inflation was better than expected, rising 0.2% over the month, less than the 0.3% increase that forecasters expected, making for a 3.4% increase over the year, again undershooting the consensus forecast for a 3.5% increase.

However, Wednesday’s favorable report likely doesn’t mean the fight against inflation is over. Fed officials have repeatedly said they are looking to economic data for signs that inflation is sustainably falling toward its 2% annual goal before cutting interest rates.

“The Fed will likely need to see another couple of months of inflation moderation to give the all-clear to cut interest rates in September,” wrote BMO’s Chief U.S. Economist Scott Anderson. “Restrictive monetary policy has more work to do, and the Fed will remain patient and watchful. However, today’s far softer CPI report will go a long way in making the case that it can soon safely ease off the monetary brake pedal without risking another inflation episode.”