Inflation Heats Up for Third Consecutive Month

Less than a week before Donald Trump is sworn in for his second term in the White House, new data published by the Bureau of Labor Statistics on Wednesday reminded us that the fight against inflation is not over yet. The Consumer Price Index for All Urban Consumers (CPI-U) increased 2.9 percent over the last 12 months before seasonal adjustment, meaning that inflation has heated up for three consecutive months after hitting a three-and-a-half year low in September 2024. Meanwhile core inflation, which excludes volatile food and energy prices, came in at 3.2 percent in December, marking the first decline in the core inflation rate since July.

Due to its weight in the Consumer Price Index, the cost of shelter continues to be a major driver of inflation these days. Rents and owners' equivalent rents of residences increased 4.3 and 4.8 percent year-over-year in December, respectively, as the index for shelter climbed for the 56th consecutive month. In fact, excluding the impact of shelter, inflation would been at or below the Fed's target level of 2 percent in 16 for the past 19 months, illustrating that housing costs have been the most stubborn driver of elevated inflation lately.

The latest inflation reading all but cemented the belief that the Fed will pause rate cuts at its January meeting after lowering the federal funds rate by a total of 100 basis points at its last three meetings in September, November and December. According to the CME FedWatch Tool, there's now a 97 percent probability of the Fed keeping its policy rate as it is in January and a 74 percent chance of the same, aka nothing, happening at the Fed's next meeting in March. June is currently considered the earliest point in time for another rate cut, but much depends on the policy choices of the incoming Trump administration, some of which, e.g. raising tariffs and deporting undocumented immigrants, are feared to add inflationary pressures.

Back in the spring of 2021, when inflation took off, the high readings could largely be explained by the so-called base effect, as prices had fallen sharply at the onset of the pandemic a year earlier, when demand for many goods and services had suddenly dried up. Due to that initial dip in consumer prices, year-over-year comparisons were exaggerated for a while, but towards the end of 2021 inflation became a real concern, which turned into a global crisis when Russia attacked Ukraine, resulting in surging food and energy prices. Now that the conflict in Ukraine has dragged on for almost three years, price levels are measured against already elevated prices, partially explaining the steep drop in inflation in the first half of 2023 and why progress has been notably slower since then.