Inflation rate slows again to 15-month low, PCE shows, as U.S. economy weakens

The numbers: The cost of U.S. goods and services rose a scant 0.1% in December in yet another sign inflation is cooling off, opening the door for the Federal Reserve to stop raising interest rates soon.

The rate of inflation, using the Fed’s preferred PCE index, has tapered off rapidly since last summer. Falling oil prices have played a big role, but inflation more broadly is easing.

The annual increase in prices slowed to 5% in December from 5.5% in the prior month and a 40-year high of 7% last summer, according to fresh government data.

That’s the smallest increase in 15 months, though still well above pre-pandemic levels of less than 2% annual inflation.

Key details: The more closely followed core index rose a modest 0.3% last month, matching Wall Street’s forecast.

The increase in the core rate of inflation in the past 12 months decelerated to 4.4% from 4.7%. That’s also the lowest level in 14 months.

The PCE index is viewed by the Fed as the best predictor of future inflation trends, especially the core gauge that strips out volatile food and energy costs.

Unlike it’s better-known cousin, the consumer price index, the PCE gauge takes into account how consumers change their buying habits due to rising prices.

They might substitute cheaper goods such as chicken thighs for more expensive ones like boneless breasts to keep costs down, or buy generic medicines instead of brand names.

The CPI showed inflation rising at a 6.5% yearly rate in December, but it’s also slowed sharply since the summer.

Big picture: The Fed is trying to restore inflation to pre-pandemic levels of 2% or so, and it will keep raising interest rates until it is convinced the genie is back in the bottle. Higher rates reduce inflation by slowing the economy.

Yet with inflation subsiding, Wall Street is raising questions about whether the Fed’s work is almost done. If rates go too high, the economy could sink into recession.

Indeed, many economists think a downturn is likely this year. The central bank has jacked up a key U.S. interest rate to a 15-year high of 4.5% from near zero less than a year ago — and the effects of higher borrowing costs are just starting to bite.

Looking ahead: “With higher interest rates evidently weighing heavily on demand now, we expect core inflation to continue moderating,” said chief North American economist Paul Ashworth of Capital Economics in a note to clients. That “will eventually persuade the Fed to begin cutting interest rates late this year.”

Market reaction: The Dow Jones Industrial Average

and S&P 500

were set to open slightly lower in Friday trades.