Tuesday’s inflation report will be critical to the direction of central bank policy

Inflation data from May showed a slowdown in price hikes that have dogged consumers for the past two years.

The question, however, is whether that drop will be enough to convince Federal Reserve officials to stop raising interest rates and let the U.S. economy breathe on its own for a while.

According to Dow Jones consensus estimates, the consumer price index, due out at 8:30 a.m. ET on Tuesday, is expected to show that all-items inflation rose just 0.1% last month, equal to a 4% annual rate. Excluding volatile food and energy components, CPI is forecast to rise 0.4% and 5.3% respectively.

After inflation rises above 9% in June 2022, those kinds of numbers will encourage policymakers that inflation is headed in the right direction.

“The most encouraging thing is that year-over-year growth rates are going to slow down very sharply,” said Mark Jandy, chief economist at Moody’s Analytics. “The headline number will be good, it will be encouraging, showing that inflation is moving in the right direction. And fundamentally, I think inflation. There is Moving in the right direction.”

Indeed, inflation has come a long way since it started to rise in the spring of 2021. Pandemic-related factors such as disrupted supply chains and higher demand for goods over services combined with trillions in monetary and fiscal stimulus sent inflation to its highest levels. Early 1980s.

After a year of insisting that inflation would not last, the central bank initiated 10 interest rate hikes in March 2022. Since then, inflation has been falling steadily, but is still far from the central bank’s 2% target.

Tuesday’s report is expected to be enough to avoid a rate hike this meeting as policymakers on the Federal Open Market Committee await incoming data and decide the long-term policy path.

“Inflation is coming and we can get a number that gives them comfort that things are moving in the right direction,” Jandy said. “They don’t need to raise rates again.”

There will be several key variables to watch in the May CBI report.

One would be anomalous: core inflation would be much stronger than headline, an unusual case where the former takes into account fewer variables and excludes hot-running food and energy. The discrepancy is largely the result of year-over-year comparisons, which can result in a period when gasoline went above $5 a gallon at the pump, which has since declined.

Another area to watch closely in the report is used vehicle prices, which rose 4.4% on a monthly basis in April and are expected to be strong again in May. Accommodation costs account for a third of the CPI weighting, but central bank officials expect them to decline later this year. Economists also expect airfare and lodging costs to rebound in May.

“Inflation has been trending downward for the past year,” said Dean Baker, co-founder of the Center for Economic and Policy Research. “If this trend continues, the Fed can declare victory and focus on the employment side of its mandate.” However, inflation remains higher than the central bank. [2%] target, so the question is whether the downward trajectory continues or whether we’ve hit a plateau.”

While market expectations are for the central bank to avoid this meeting, a final hike in July is considered before an extended pause, which is now expected to last into early 2024. A CME group gauge Trade in the Fed Fund futures market.

The CPI report ahead of the central bank’s July 25-26 meeting and another month’s worth of data could go a long way in determining whether the market is OK or whether officials decide they have more work to do.

“Whether or not they get a soft landing depends on how inflation pans out,” said Bill English, a former Fed official who is a professor of finance at the Yale School of Management. “If inflation is high, they’ll have to raise rates even more. That could be the path to employment and the path to productivity, which is not what you want to see inflation get down to 2% in a couple of years.”