- US inflation cooled marginally in December, but underlying price pressures remain elevated
- Food inflation surged at its fastest pace since 2022, weighing on consumer affordability
- Economists warn that PCE inflation is likely to run hotter than CPI
- The Federal Reserve appears increasingly comfortable with inflation hovering near 3%
US inflation data initially looked encouraging, but a closer reading suggests price pressures remain more persistent than headline numbers imply. While December’s Consumer Price Index showed a modest easing in core inflation, rising food costs and underlying dynamics point to continued upside risks for the Federal Reserve’s preferred inflation gauge.
Markets reacted cautiously to the data, with investors reluctant to price in aggressive rate cuts. According to Reuters, the latest figures reinforce concerns that inflation may settle above the Fed’s 2% target for longer than policymakers initially hoped.
US CPI Cools, but Food Inflation Accelerates
Headline CPI rose 2.7% year-on-year in December, matching expectations, while core inflation slowed slightly to 2.6%, undershooting forecasts by a tenth of a percentage point. On the surface, this suggested easing price pressures.
However, food prices jumped 0.7% month-on-month, the largest increase since October 2022, pushing annual food inflation to 3.1%. Reuters noted that this sharp rise underscores ongoing affordability challenges for households, particularly as energy prices show early signs of firming amid geopolitical uncertainty.
For consumers, food and fuel costs matter far more than abstract inflation measures. This divergence explains why inflation still feels uncomfortably high despite modest progress in headline indicators.
PCE Inflation Likely to Run Hotter Than CPI
Economists caution that CPI may be understating inflation risks faced by policymakers. The gap between CPI and the Fed’s preferred Personal Consumption Expenditures (PCE) inflation measure continues to widen.
Reuters reported that economists at Barclays and Morgan Stanley revised their December PCE forecasts higher, with monthly readings expected near 0.5%. That pace would lift annual PCE inflation toward 2.8%–2.9%, well above the Fed’s target.
Unlike CPI, which uses a fixed basket of goods, PCE better reflects actual consumer spending patterns. Analysts argue that areas where consumers are actively allocating income are seeing renewed price pressure, increasing the likelihood that upcoming PCE data will surprise to the upside when released.
Has the Fed Quietly Accepted 3% Inflation?
Federal Reserve officials continue to publicly reaffirm their commitment to the 2% inflation target, but messaging suggests growing tolerance for inflation hovering closer to 3%.
New York Fed President John Williams recently said inflation could remain near 3% in the first half of the year before easing later. Reuters noted that inflation has now been above target for nearly five years, and current projections imply that stretch could extend closer to six.
Several structural factors may keep inflation elevated, including tight housing supply, potential energy shocks, tariff pass-throughs, and demand driven by fiscal stimulus expectations. While not all risks may materialise, the balance of probabilities points to inflation remaining sticky rather than decisively falling.
What the CPI and PCE Gap Means for Markets and Fed Policy
For markets, the takeaway is clear. Inflation is cooling, but not fast enough to justify rapid monetary easing. This reinforces a cautious Fed stance and limits the scope for aggressive rate cuts in the near term.
Consumers and policymakers alike may need to adjust to a world where inflation stabilises closer to 3% than the pre-pandemic norm of 2%.
Outlook
US inflation may no longer be accelerating, but it is far from defeated. With food prices rising sharply and PCE inflation likely to exceed CPI, the Federal Reserve faces a delicate balancing act. Until underlying pressures ease more convincingly, expectations for swift policy relief remain vulnerable to disappointment.