Despite recent banking industry instability, inflation climbed in February but remained in line with expectations, possibly keeping the Federal Reserve on track for another interest rate hike next week.
According to the Labor Department, the consumer price index gained 0.4% for the month, bringing the annual inflation rate to 6%. Both readings were exactly in line with Dow Jones estimates.
Excluding volatile food and energy prices, core CPI rose 0.5% in February and 5.5% on a 12-month basis. The monthly number was somewhat ahead of the 0.4% expectation, while the annual level remained in line.
Markets surged following the publication, with the Dow Jones Industrial Average \s up more than 300 points in early trading. Treasury rates, which fell Monday over fears over the banking industry’s health, returned solidly, driving the policy-sensitive 2-year note \s up 30 basis points to 4.33%.
Going into the release, markets had widely expected the Fed to approve another 0.25 percentage point increase to its benchmark federal funds rate. Following the CPI report, traders are now pricing in an 85% chance that the Fed will raise interest rates by a quarter point, according to a CME Group estimate.
“Even in the face of current financial concerns, the Fed will continue to emphasize price stability above growth and will most likely raise rates by 0.25% at the forthcoming meeting,” said Jeffrey Roach, chief U.S. economist at LPL Financial.
Energy cost cuts aided in keeping the headline CPI reading in control. For the month, the sector fell 0.6%, bringing the year-over-year increase to 5.2%. A 7.9% fall in fuel oil prices was the largest mover for energy.
Food prices rose 0.4% and 9.5%, respectively. Meat, poultry, fish, and egg prices declined 0.1% for the month, the first time that the index has retreated since December 2021. Eggs, in particular, fell 6.7% but were still up 55.4% year on year.
Housing expenses, which make up around one-third of the index’s weighting, increased by 0.8%, bringing the yearly gain up to 8.1%. Housing and related costs, such as rent, are expected to slow over the course of the year, according to Fed officials.
“Housing costs are a crucial driver of inflation estimates, but they are also a lagging indication,” said Lisa Sturtevant, Bright MLS’s chief economist. “New rent data typically takes six months to be reflected in the CPI. The peculiarity in the collection of housing cost data contributes to an overestimation of current inflation.”
However, shelter expenses accounted for more than 60% of the total CPI increase and climbed at the quickest annual pace since June 1982.
Due of rising house prices, Fed officials have added “super-core” inflation to their toolbox. This includes core services inflation excluding housing, which rose 0.2% in February and 3.7% year on year, according to CNBC calculations. The Fed targets inflation at 2%.
Used vehicle prices, a key component when inflation first began surging in 2021, fell 2.8% in February and are now down 13.6% on a 12-month basis. New vehicles have risen 5.8% over the past year, while auto insurance has climbed 14.5%. Apparel rose 0.8%, while medical care services costs decreased 0.7% for the month.
The CPI measures a broad basket of goods and services and is one of several key measures the Fed uses when formulating monetary policy. The report along with Wednesday’s producer price index will be the last inflation-related data points policymakers will see before they meet on March 21-22.
Banking sector turmoil in recent days has kindled speculation that the central bank could signal that it soon will halt the rate hikes as officials observe the impact that a series of tightening measures have had over the past year.
On Tuesday morning, markets were pricing a peak, or terminal, rate of about 4.95%, implying that the upcoming increase may be the last. Futures pricing is volatile, though, and unexpectedly strong inflation reports this week likely would cause a repricing.
Either way, market sentiment has shifted.
Fed Chairman Jerome Powell told two congressional committees last week that the central bank is prepared to raise interest rates sooner than expected if inflation does not fall. This sparked speculation that the Fed might raise interest rates by 0.5 percentage points next week.
However, the recent failures of Silicon Valley Bank and Signature Bank have paved the way for a more cautious approach to monetary policy.
“Although only marginally higher than anticipated, in the pre-SVB crisis environment this may easily have driven the Fed to boost 50bp at its March meeting next week. “It is a sign of how much has changed in the very short time that 50bp is very definitely still off the table for March,” commented Krishna Guha, Evercore ISI’s head of global policy and central bank strategy.
Guha believes the Fed might continue to raise rates to a terminal rate in the “high 5s” if its attempts to restore banking stability are effective.