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Weekly Update 1/13/2023: U.S. Inflation Cools Again Setting Stage for Fed to Slow the Pace of Interest Rate Hikes

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Domestic Economic News

US inflation continued to slow in December, adding to evidence price pressures have peaked and putting the Federal Reserve on track to again slow the pace of interest-rate hikes. The overall consumer price index fell 0.1% from the prior month, with cheaper energy costs fueling the first decline in 2 1/2 years, according to a Labor Department report Thursday. The measure was up 6.5% from a year earlier, the lowest since October 2021. Excluding food and energy, the so-called core CPI rose 0.3% last month and was up 5.7% from a year earlier, the slowest pace since December 2021. Economists see the gauge — known as the core CPI — as a better indicator of underlying inflation than the headline measure. The data, when paired with prior months’ lower-than-expected readings, point to more consistent signs that inflation is easing and may pave the way for the Fed to downshift to a quarter-point hike at their next meeting ending Feb. 1. That said, the central bank’s work is far from over. Resilient consumer demand, particularly for services, paired with a tight labor market threaten to keep upward pressure on prices. The Fed is expected to raise interest rates further before pausing to assess how the most aggressive tightening cycle in decades is impacting the economy. Policymakers have emphasized the need to hold rates at an elevated level for quite some time and cautioned against underestimating their will to do so. Investors are still betting the central bank will cut rates by year end, despite officials saying otherwise. All of the figures matched the median estimates in a Bloomberg survey of economists.

Shelter costs — which are the biggest services component and make up about a third of the overall CPI index — increased 0.8% last month, an acceleration from November. Rents and owners’ equivalent rent both rose by the same amount, while hotel stays advanced 1.5% after falling in the prior month. Because of the way this category is calculated, there’s a delay between real-time measures — which currently show rents are beginning to decline — and the Labor Department data. Stripping out energy, rent and owners’ equivalent rent, services prices were up 0.3%, according to Bloomberg calculations. Fed Chair Jerome Powell and his colleagues have stressed the importance of looking at such a metric when assessing the nation’s inflation trajectory. Removing medical care as well, an adjustment that helps offset a quirk in the CPI’s calculation of health insurance, services prices were up by a similar amount. Given wages make up a large share of these businesses’ costs, economists expect the labor market to play a key role in the inflation outlook. The latest jobs report showed some cooling in earnings growth, but hiring remains robust and the unemployment rate fell to match a five-decade low. The persistent imbalance between labor supply and demand remains firmly entrenched, underpinning wage growth and consumer spending at a time when the Fed is trying to slow it down. A separate report Thursday showed inflation-adjusted average hourly earnings rose 0.4% from the prior month, the most in five months. Still, they were down 1.7% from a year earlier. Other data showed applications for unemployment benefits remained historically low last week.

US consumer borrowing climbed in November by more than forecast as credit-card balances increased by the most in three months. Total credit rose $28 billion from the prior month, Federal Reserve figures showed Monday. The median forecast in a Bloomberg survey of economists called for a $25 billion advance. The figures aren’t adjusted for inflation. Revolving credit outstanding, which includes credit cards, rose $16.5 billion. Non-revolving credit, such as loans for school tuition and vehicle purchases, increased $11.5 billion, the smallest advance since the start of last year. While inflation is beginning to ease, it remains extremely elevated and continues to weigh on households. A December survey by the Census Bureau showed Americans are increasingly relying on credit cards to cover daily expenses. Meantime, rising borrowing costs, the Fed’s main tool to fight inflation, has made buying homes and cars less affordable.

US mortgage rates retreated for the first time in three weeks, helping provide a modest lift to refinancing activity. The contract rate on a 30-year fixed mortgage decreased 16 basis points to 6.42% in the week ended Jan. 6, according to Mortgage Bankers Association data released Wednesday. That helped boost applications for refinancing, which rose 5.1% in the week. Even with last week’s advance, the refinancing index remains near the lowest level in two decades. Mortgage rates have more than doubled in the last year as the Federal Reserve increases borrowing costs to rein in inflation, which has hampered activity in the housing market. Homeowners who locked in low rates in the last two years are staying put, keeping applications to purchase depressed. MBA’s purchasing index eased 0.5% last week to an eight-year low. The MBA survey, which has been conducted weekly since 1990, uses responses from mortgage bankers, commercial banks and thrifts. The data cover more than 75% of all retail residential mortgage applications in the US.

Interest Rate Insight and the Fed

Federal Reserve Bank of Atlanta President Raphael Bostic said he’s leaning toward supporting a smaller interest-rate hike at the Fed’s next meeting following Thursday’s report showing a further slowing in inflation. “This report was really welcome news,” Bostic said in an interview Thursday evening with CBS News. “It really suggests that inflation is moderating and it gives me some comfort that we might be able to move more slowly now that we are in restrictive territory.” Fed officials, who meet Jan. 31-Feb. 1, are mulling a further moderation in the pace of rate hikes following a slowing in US inflation. Consumer prices rose 6.5% in the 12 months through December, marking the slowest inflation rate in more than a year, Labor Department data showed. “If the information I get from business leaders and others is consistent with that, and the first signals we are getting is they are, I’ll be comfortable moving at a slower rate, even 25 basis points, relative to what you saw us do through 2022,” said Bostic, who does not vote on monetary policy this year. Fed officials lifted rates by a half-point last month to a target range of 4.25% to 4.5%, slowing the pace of rate increases after four straight 75 basis-point moves. Fed officials see interest rates rising above 5% this year and staying there until 2024, according to projections released by policymakers last month. Philadelphia Fed President Patrick Harker, speaking Thursday morning shortly after the Labor Department’s release of consumer price data, said rate hikes of a quarter-percentage point “will be appropriate going forward.” Harker’s comments echoed remarks a day earlier from Susan Collins, his counterpart at the Boston Fed. Investors hardened bets on a 25 basis point hike following the release of the data, according to pricing in futures contracts.

Impactful International News

China’s factory-gate deflation narrowed last month even as rising virus infections snarled factory operations, while a small uptick in consumer inflation will likely still leave the central bank room to ease policy and bolster the economy. The producer price index fell 0.7% in December from a year earlier after declining 1.3% in the previous month, the National Bureau of Statistics said Thursday. Economists surveyed by Bloomberg had expected a 0.1% drop. Consumer inflation gained 1.8% compared with a 1.6% increase in November, in line with economist expectations. Core inflation, which excludes volatile food and energy prices, picked up slightly to 0.7% after staying unchanged at 0.6% for three straight months. Consumer prices “were generally stable” in December thanks to multiple measures to ensure market supply and price stability, said Dong Lijuan, chief statistician at the NBS. The bigger-than-expected decline in PPI, meanwhile, reflects “the virus damage on industrial demand during the month,” said Zhou Hao, chief economist at Guotai Junan International Holdings. There was little reaction in Chinese stocks to the data, with the CSI 300 Index trading up 0.2% at 10:38 a.m. in Shanghai. The yuan was 0.1% stronger against the greenback. Surging infections following the abrupt reversal of Covid Zero pushed activity off a cliff as people became ill or stayed home for fear of catching the virus — contributing to what other economic indicators have suggested was the weakest month for China’s activity since early 2020. Factory production and new orders in December both contracted the most since April 2022, during Shanghai’s lockdown. Major cities experiencing outbreaks did not begin to rebound until near the end of the month, high frequency data measuring subway usage and other mobility data showed. We expect a significant pick-up in activity once these waves of Covid infections peak then eventually subside.

Europe’s two biggest economies may have succeeded in skirting a recession in the fourth quarter, defying downbeat expectations and offering hope of similar feats throughout the advanced world. Consumer-fueled momentum buoyed both Germany and the UK, according to official estimates of gross domestic product released Friday. Officials in Berlin suggested the euro zone’s motor probably stagnated in the quarter, while British data for November showed output rose unexpectedly by 0.1%. With both economies labeled just weeks ago by the OECD as this year’s likely laggards within the Group of Seven, generous subsidies for energy bills are cushioning households against the worst cost-of-living crisis in a generation. It raises the possibility of a soft landing for the world economy. Further reasons for hope come from China’s emergence from Covid-19 lockdowns and warmer weather in Europe, which is reducing energy demand and reliance on Russia for supplies. At the same time, there’s a danger that inflation stoked by stronger demand could persist. That would complicate decision making by central banks from the US to the euro zone, which are struggling to decide how much further interest rates need to rise to quell price pressures. “Germany and the UK are very much in the same situation — high inflation meets generous fiscal support and an economy saved by the weather,” said Carsten Brzeski, head of macro at ING in Frankfurt. Still, “while the data offer some hope that the crisis won’t be as bad as feared, I’m struggling to think of 2023 as a year where everything will be just fine.” As recently as November, the European Commission was forecasting that Germany was succumbing to the deepest recession in the euro region, which itself was predicted to mildly contract during the fourth and first quarters. The UK, according to its officials, was already in the midst of an even more severe slump — a projection shared by the Bank of England.

Instead, both economies are showing unexpected resilience. Germany — whose initial and tentative fourth-quarter assessment by statisticians is the first for any G-7 country so far — expanded 1.9% in 2022 as a whole. That’s more than the 1.8% median prediction of economists. Britain, meanwhile, showed a second consecutive month of expansion, an outcome foreseen by only one forecaster among 32 polled. While different narratives affect each country, not least since the UK’s exit from the European Union in 2020, the unifying theme in each is the continuation of wholesale support to consumers to weather the cost-of-living squeeze. “The UK is definitely holding up better than everyone thought a few months ago,” said James Smith, developed markets economist at ING. He pointed to the cap on energy bills as freeing up spending capacity for households. In Germany, disposable income in 2022 posted a record increase, aided by Chancellor Olaf Scholz’s coalition. Ministers offered a tax break on bonuses, and most emphatically they ensured that gas bills in December were bankrolled by the public purse. This was pretty good news this week on the international economic front.

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