Consumer Inflation Slowed in December

Consumer inflation moderated in December to the lowest in more than a year, suggesting that the Federal Reserve is making headway in its battle to crush inflation by raising interest rates.

The Consumer Price Index (CPI) declined 0.1% in December from a month earlier, the first month of deflation since May 2020. On an annual basis, price growth decelerated to 6.5% from 7.1% in November, in line with consensus estimates and the lowest since October of 2021. While inflation has slowed significantly from a 40-year high of 9.1% in June, it remains more than triple the Fed’s target rate of 2%.

Core inflation, which strips away volatile food and energy prices, dropped to 5.7% from 6% in November, the slowest rate since December 2021.

Stocks fluctuated between early gains and losses before settling higher, while bond yields fell in response to the latest CPI print. Crude oil prices rallied, while the dollar fell against major peer currencies as the U.S. Dollar Index (DXY) hit a seven-month low.

Breakdown by Category

Falling energy prices were the primary contributor to the slight decline in the CPI last month. The energy index fell 4.5% in December, led by a 9.4% decline in gasoline prices and a 16.6% plunge in prices for fuel oil. On an annual basis, price gains decelerated to 7.1%, down from 13.1% in November. Gasoline prices are now 1.5% lower compared to the same period of 2021.

Food prices continued to moderate, rising just 0.3% compared to a 0.5% increase in November. They were up 10.4% year-over-year, down from 10.6% in November and a recent peak of 11.4% in August. Food at home prices—a category that includes groceries and other household staples—rose 11.8%. Prices for food away from home—a category that includes eateries, bars, and restaurants—rose 8.6%.

Prices for used cars and trucks—a primary driver of inflation earlier in the pandemic—fell for the sixth consecutive month and are now 8.8% lower on an annual basis. Prices for new vehicles also registered a decline, with annual gains moderating to 5.9%.

In recent months, services inflation has outpaced goods inflation, as consumers have shifted their buying preferences from goods to services. Costs of services were up 7% year-over-year in December, outpacing the overall CPI print by 0.5 percentage points. Within the category, transportation services recorded the biggest annual increase, rising 14.6%. Costs for shelter and medical care services gained 7.5% and 4.1%, respectively.

Implications for Fed Policy

The Fed raised its benchmark federal funds rate by a cumulative 425 basis points since March in an effort to tame inflation.

Policymakers are likely to cap their next rate hike at 25 basis points, or a quarter of a percent, at a meeting of the Federal Open Market Committee (FOMC) scheduled for Jan. 31-Feb. 1. Fed funds futures now indicate a greater than 90% probability of a 25-bp hike, according to the CME Group’s FedWatch Tool. Fed officials anticipate three more rate hikes this year, each by 25 basis point increments, or a terminal fed funds rate between 5% and 5.25%.