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August Saw a Decrease in the Inflation Measure Preferred by the Federal Reserve

Federal Reserve officials received more good news in their battle against rapid inflation on Friday, when a key inflation measure continued to slow, the latest evidence that a return to normal after the pandemic and higher interest rates are combining to wrestle rapid price increases back to a more normal pace.

The Personal Consumption Expenditures Index, which the central bank uses to define its 2 percent inflation goal, rose slightly more quickly last month as higher gas prices gave it a boost. It rose 3.5 percent in August from a year earlier, up from 3.4 percent in July.

But after subtracting food and fuel costs, which can be volatile, a “core” inflation measure that Fed officials closely monitor is starting to cool significantly. That measure increased by 3.9 percent from a year earlier, down from 4.3 percent in July. Compared with the previous month, it increased by 0.1 percent, a very slow pace.

This is the latest positive sign for Fed policymakers, who have been raising interest rates since March 2022 to slow the economy and reduce price increases. While the economy has fared better than expected, a less robust housing market and a gradual return to normalcy in the car market have contributed to the leveling off of key prices, such as automobile and rents.

At the same time, supply chain disruptions that led to shortages and significant price increases in 2021 have been gradually resolving, allowing costs for many goods to stabilize or even decrease slightly.

“I don’t think they’re fully confident yet that core inflation has sustainably slowed; this is adding another building block to gaining that confidence,” said Omair Sharif, founder of the research firm Inflation Insights.

Given this progress, central bankers are now considering whether they need to further raise interest rates. They have kept rates unchanged, in the range of 5.25 to 5.5 percent, at their meeting this month but have indicated that they may need to maintain high interest rates for a longer period to ensure a sustainable return to normal inflation, considering the strength of the economy.

“We’re taking advantage of the fact that we have moved quickly to move a little more carefully now,” said Jerome H. Powell, the Fed’s chair, during a news conference after the Fed’s meeting last week.

Mr. Sharif stated that he believes the Fed could delay a rate increase in November based on the latest inflation report, but an increase in December is still possible as inflation may slightly accelerate this autumn.

“I don’t think this takes another rate hike off the table just yet; I don’t think they’re fully confident yet, and I don’t think they should be,” he said.

Market pricing suggests that investors see roughly a one-third chance of a rate increase in December as of Friday morning. Longer-term bond yields have also risen in recent weeks, indicating that Wall Street is increasingly convinced that the Fed will maintain higher policy rates for a longer period. Stocks increased after Friday’s report.

“This is certainly very welcome news. The stock market loves it, the Treasury market loves it, and I think that’s the right reaction,” said Ian Shepherdson, chief economist at Pantheon Macroeconomics. “They’re not going to declare victory based on this report,” but “the emerging downward trend is pretty clear now.”

A key question now is whether inflation can fully fade – returning to something close to the Fed’s 2 percent target and staying there – without a more significant economic slowdown.

So far, the economy has maintained surprising momentum. Retail sales figures and company earnings calls have indicated that American consumers are continuing to spend, despite higher borrowing costs that have made it more expensive to finance large purchases.

However, Friday’s report also contained good news for the Fed in terms of consumption. Consumers continued to spend, but not as enthusiastically. The report showed that personal consumption expenditures increased by 0.4 percent in August from the previous month, a slowdown compared to July and below economists’ expectations.

Historically, it has been challenging for the Fed to lower inflation without causing a significant economic slowdown. Companies generally raise prices if they can, so it requires reduced demand to compel them to stop. Fed policy is a blunt tool, making it difficult to calibrate precisely.

Nevertheless, risks still remain. The government is heading towards a potential shutdown, which could harm economic growth if it persists. Strikes in the auto industry could disrupt car and parts production if they are prolonged, and high crude oil prices could affect inflation if they translate into higher prices at the pump.

Despite these challenges, as price increases subside and the economy stabilizes, central bankers have expressed optimism about achieving a rare “soft landing” by cooling price increases without jeopardizing economic growth.

“We will get inflation back to our target, whatever it takes,” said Austan Goolsbee, president of the Federal Reserve Bank of Chicago, during a speech this week. “But we also can’t lose sight of the fact that the Fed has the chance to achieve something quite rare in the history of central banks: to defeat inflation without tanking the economy.”

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