Inflation data gives Fed doves stronger hand for rate-hike downshift

The latest evidence of cooling inflation not only reinforced the Federal Reserve’s likely decision for a smaller interest-rate hike this week – it also bolsters the hand of dovish officials to push for a further downshift and then go on hold.

A key gauge of the U.S. consumer price index – so-called core inflation, which excludes food and energy – posted its smallest monthly advance in more than a year last month, according to a Labor Department report published Tuesday.

The moderation was broad-based, with an indicator of services prices favored by Fed Chair Jerome Powell also decelerating.

The U.S. central bank is expected to raise the target range for its benchmark interest rate by a half-percentage point Wednesday, to 4.25 to 4.5%, following four straight moves of 75 basis points.

Officials will also unveil updated quarterly projections for how high they project rates going next year.

Fed watchers said the inflation data probably didn’t arrive in time to avert an upward revision to show a peak rate around 5%, though the numbers do strengthen the case for an ongoing moderation in the pace of tightening.

“I suspect that the projections were locked in before the weekend and will thus not reflect today’s numbers,” said Aneta Markowska, the chief financial economist at Jefferies in New York.

“I was assuming another 50 basis-point hike in February, but I think the doves will be pushing strongly for a 25 basis point increase, and they certainly have a stronger case after today’s release.”

This week’s decision will be announced Wednesday at 2 p.m. in Washington and Powell will hold a press conference 30 minutes later. The Fed’s next decision after that is due Feb. 1.

Stocks surged Tuesday following the release of the Labor Department report, and bond yields fell.

“The November CPI report was a second month of good news on inflation, and December’s report will likely bring a third. While we think it’s still unclear if non-shelter core services prices are slowing meaningfully, the string of soft reports should embolden the growing contingent inside and outside the Fed calling for a pause in rate hikes soon,” economists Anna Wong and Eliza Winger wrote in a note for Bloomberg Economics.

While the inflation data are moving in the right direction, Fed officials have stressed they want to see a string of positive monthly reports before significantly altering course.

They also may worry about the market reaction to the data because looser financial conditions will make it easier for businesses and households to obtain credit, said Brett Ryan, a senior U.S. economist at Deutsche Bank in New York.

“Today’s print makes it easier for the Fed to continue to step down the pace of hikes to 25 basis points at the February meeting, but it probably won’t have much of an impact on the broader inflation picture for the Fed,” Ryan said.

“Easing of financial conditions is counter to their goal of bringing supply and demand into balance. Hence, we think officials will lean against that.”