Hopes for an imminent pause in the Federal Reserve’s interest rate hiking campaign were dashed on Tuesday as new data showed consumer prices rose more than forecast last month. The stubbornly high inflation figures make it likely the central bank will extend its most aggressive policy tightening cycle since the 1980s.
The Consumer Price Index climbed 0.4% from January and 3.2% annually in February, according to the Bureau of Labor Statistics. That exceeded all estimates in a Bloomberg survey of economists who had projected a 0.3% monthly gain and a 3.1% year-over-year increase.
Stripping out volatile food and energy costs, the core CPI accelerated to 0.4% for the month and 3.8% from a year ago, also topping projections. The surprisingly hot readings marked an unwelcome re-acceleration after months of gradually cooling price pressures had buoyed expectations that the Fed may be able to begin cutting rates before year-end.
The data landed like a bucket of cold water on hopes that had been building across financial markets in recent weeks. Investors swiftly repriced their bets, now seeing around a 90% chance that the Fed’s policy committee will raise interest rates by another quarter percentage point at their March 22nd meeting. As recently as Friday, traders had been leaning toward no change in rates next week.
“After taking a step back the last couple of months, it appears inflation regained its footing in February,” said Rubeela Farooqi, chief U.S. economist at High Frequency Economics. “A re-acceleration could mean a longer period of policy restrictiveness is required to bring it down on a sustained basis.”
The biggest driver of February’s price spike was housing, which accounts for over 40% of the CPI calculation. Shelter costs surged 0.4% for the month and are now up a sizable 5.7% versus a year ago. While down from their 2022 peaks, those increases remain far too hot for the Fed’s comfort.
Rents rose 0.5% in February while the owners’ equivalent measure, which tracks costs for homeowners, jumped 0.4%. Both measures are watched closely by policymakers, as housing represents the heaviest weight in the index and tends to be one of the stickier components of inflation.
David Tulk, senior portfolio manager at Allianz Global Investors, said the latest shelter prints mean “the Fed’s path to restoring price stability is going to be a tough one.” He added that debate among central bankers over whether to raise rates by a quarter percentage point or go for a more aggressive half-point move now seems “settled in favor of 25 basis points.”
Energy and gasoline prices also contributed heavily to February’s elevated inflation figures. The energy index rose 2.3% last month, fueled by a 3.8% surge in gas costs. Those pressures could intensify further after recent OPEC production cuts.
Food prices were relatively contained last month, holding steady from January levels. But overall grocery costs are up 10.2% versus a year ago as the battered supply chains and labor shortages stemming from the pandemic continue to reverberate.
While this latest inflation report dealt a significant blow to hopes for an imminent pivot toward easier Fed policy, economists are still forecasting price pressures to ease over the year thanks to cooling pipeline pressures from housing and wages.
However, reaching the Fed’s 2% inflation target is likely to require a measure of demand destruction and labor market softening that could potentially tip the economy into recession. It remains to be seen if central bank policymakers will be able to orchestrate the elusive “soft landing” they have long aimed for.