The December Consumer Price Index (CPI) showed that inflation rose by 3.4% from a year earlier, vs. 3.1% in November and 6.4% at the beginning of 2023. Meanwhile, core CPI, which excludes volatile food and energy prices, rose by 3.9% in December from a year earlier, vs. 4.0% y/y in October and 5.6% y/y at the beginning of 2023.

Federal Reserve Chair Powell has noted that the path to the Fed’s 2% inflation target would be ‘lumpy and bumpy’ and we agree. While headline inflation rates have fallen dramatically since earlier in 2023, this reading does show a bump. Energy prices, which spiked in Q3 2023, fell in October and November and helped to drive CPI lower those months. However, the December data no longer benefited from this trend as energy prices stabilized. Shelter prices continue to be one of the primary drivers of inflation and picked up slightly in December in month-on-month terms. However, in year-on-year terms shelter prices continued to decelerate. We expect shelter prices to continue to cool in 2024 and to bring additional relief to the headline CPI.

Based on these data, the Federal Reserve will likely hold rates steady at the conclusion of the January FOMC meeting. However, as inflation rates continue to slow over the next several quarters we expect the Fed to begin cutting rates starting in June. Provided that inflation settles around 2 percent before the end of the year, which is our forecast, we should see steady rate cuts of 25 basis point at subsequent FOMC meetings that push the Fed Funds rate to nearly 4% by year end. Further interest rate reductions are expected in early 2025.

Data Details

Headline CPI rose by 0.3% month-on-month and 3.4% y/y, vs. November’s 0.1% m/m and 3.1% y/y. Month-on-month shelter prices continued to rise in December, contributing more than half of the all items increases, according to the Bureau of Labor Statistics (BLS). However, in year-on-year terms shelter price increases continued to decelerate. Energy prices also rose slightly in the month following several months of decline. Finally, food prices rose 0.2 percent month-on-month, as they did in November.

Core CPI rose by 0.3% m/m and 3.9% y/y, vs. November’s 0.3% m/m and 4.0% y/y. According to the BLS, the core CPI was driven by shelter, motor vehicle insurance, and medical care in December.