Gasoline prices on a sign at a Shell gas station in San Francisco, California, on Tuesday, May 23, 2023.
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May inflation data will show that price increases that have been weighing on consumers for two years are easing.
The question, however, will be whether this slowdown will be enough to convince Federal Reserve officials that they can stop raising interest rates and let the US economy breathe on its own for a while.
The Consumer Price Index, due to be released Tuesday at 8:30 a.m. ET, is expected to show headline inflation rising just 0.1% over the last month, an annual rate of 4%, according to the Dow Jones consensus estimate. Excluding the volatile food and energy components, the CPI is expected to rise 0.4% and 5.3%, respectively.
Such numbers could reassure policymakers that inflation is headed in the right direction after peaking at over 9% in June 2022.
“The most encouraging thing is that year-over-year growth rates are going to be down pretty sharply,” said Mark Zandi, chief economist at Moody’s Analytics. “The headlines will feel good, they will be encouraging and show that inflation is moving in the right direction. Basically, I think inflation is moving in the right direction.”
In fact, inflation has come a long way since it started rising in spring 2021. Pandemic-related factors such as congested supply chains and outsized demand for goods over services, combined with trillions in monetary and fiscal stimulus, pushed inflation to its highest level since the early 1980s.
After a year of insisting that inflation would not continue, the Fed began a series of ten rate hikes in March 2022. Since then, inflation has gradually eased but is still far from the central bank’s 2 percent target.
Tuesday’s report is expected to be enough to persuade policymakers on the Federal Reserve’s FOMC to forego a rate hike at this week’s meeting as they await incoming data and decide the longer-term policy stance.
“Inflation is coming and they may get a number that gives them confidence that things are going in the right direction,” Zandi said. “You don’t have to raise interest rates again.”
What to see
There will be several key variables to consider in the May CPI report.
One of them will be an anomaly: core inflation will likely appear much stronger than headline inflation. An unusual occurrence is that the former takes fewer variables into account and excludes food and energy, which tend to get hotter. The discrepancy is largely the result of year-on-year comparisons, which will mark a period in which the price of gasoline at the pump rose to over $5 a gallon, a condition that has since moderated.
Another part of the report worth looking at is used car prices, which rose 4.4% monthly in April and are expected to be high again in May. Housing costs account for about a third of the CPI weight, but Fed officials expect them to fall later this year. Economists also expect flight and accommodation costs to rise again in May.
“Inflation has trended downward over the past year,” said Dean Baker, co-founder of the Center for Economic and Policy Research. “If this trend continues, the Fed can declare victory and focus on the employment side of its mandate. However, inflation is still well above that of the Fed.” [2%] So the question is will the downtrend continue or have we reached a plateau.”
While the market is expecting the Fed to refrain from raising rates at its Tuesday-Wednesday meeting, a final rate hike is seen as likely in July before an extended pause, now expected to last into early 2024, as of CME Group measurement of trading in the fed funds futures market.
The CPI report, as well as another month’s worth of data ahead of the July 25-26 Fed meeting, could go a long way in determining if the market is on the right track — or if officials decide they have more work to do .
“Whether or not they get a soft landing depends in large part on how inflation plays out,” said Bill English, a former Fed official and now a finance professor at the Yale School of Management. “If inflation stays high, they simply have to raise rates more. Perhaps the trajectory for jobs and output consistent with bringing inflation down to 2% in a couple of years is not what you want.”
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