Modest softening in consumer price inflation in December is a positive signal that underlying inflationary forces will likely continue to moderate and allow the Fed to resume rate cuts in H2. While the Consumer Price Index (CPI) is not the measure the Fed uses to guide monetary policy, it is a useful gauge for determining the direction of the Personal Consumption Expenditure (PCE) deflator, which is the Fed’s preferred inflation metric.

Trusted Insights for What’s Ahead^®

• Continued health in the labor market, strong tracking for Q4 real GDP growth, and sticky core inflation suggest the Fed may delay the next rate cut until July.
• We anticipate 25bp of cuts each in July, September and December, which would lower the federal funds rate target range to 3.50-3.75 percent by yearend.
• This path is also consistent with our call for consumer inflation to stabilize at the Fed’s 2-percent target around mid-2026.

Figure 1. Core CPI inflation ticked down

Sources: Bureau of Labor Statistics, Bureau of Economic Analysis, and The Conference Board.

Nevertheless, despite Core Consumer Price Index (Core CPI) inflation ticking lower, there remains tremendous uncertainty about the future path of inflation and how it will be affected  the new administration policies, which  will likely keep the Fed on hold in H1.

Total CPI inflation rose (0.4 percent on a month-over-month basis from 0.3 percent prior) in December driven by a large increase in gasoline prices, while Core CPI edged lower to  reveal a 0.2 percent increase from a 0.3 percent rise in the prior period.

The CPI data combined with Producer Price Index (PPI) results released a day earlier suggest that the PCE deflator, which the Fed bases monetary policy on , likely will reveal only modest slowing in underlying inflation in December when released at the end of this month.

Report Highlights

Total Inflation Rises on Food and Energy

Total CPI rose by 0.4 percent month-over-month in December, picking up pace after a series of 0.2 percent prints in the middle of 2024. Driving the uptick were prices for food and energy, while Core CPI inflation slowed  to 0.2 percent from 0.3 percent in the prior month. On a year-over-year basis, CPI inflation roseto 2.9 percent from 2.7 percent, the highest reading since July 2024. Core goods prices ticked higher (0.1 percent) mainly driven by continued outsized monthly gains in both new and used vehicle prices. Core services remained sticky at 0.3 percent month-over-month (unchanged from the prior month) as rent of primary residence (RPR) and owners’ equivalent rent (OER) rebounded from a sharp rise in November .

Figure 2. Total CPI inflation picks up pace

Sources: Bureau of Labor Statistics, Bureau of Economic Analysis, and The Conference Board.

Figure 3. Offsetting Forces Drive Goods Inflation

Sources: Bureau of Labor Statistics and The Conference Board.

Core Goods in Deflation, Services Remain Sticky

Core CPI, or total prices less food and energy, rose by 0.2 percent, a tick down from 0.3 percent prior. This caused the year-over-year rate to tick down  slightly to 3.2 percent from 3.3 percent.

While core goods prices eked out a 0.1 percent gain in the month, most of it was driven by continued outsized gains in motor vehicle prices, which is at least partially driven by the impact of recent hurricanes in the Southeast of the country. Raging California wildfires may prop up more demand for motor vehicles in the beginning of the year and support in inflation in these categories. Excluding used vehicles, core goods prices declined by 0.1 percent.

Nevertheless, services inflation remains stubborn. A rebound in RPR and OER points to ongoing yet very gradual slowing  in housing related prices. Additionally, motor vehicle insurance (0.4 percent) costs increased and will likely continue to rise along with homeowners insurance due to more frequent and expensive natural disasters in the US.

Figure 4. Services keeping core inflation sticky

Sources: Bureau of Labor Statistic, and The Conference Board.

Fed challenged by structural changes

Persistent stickiness in several subcomponents of consumer price inflation reflect structural changes in the economy that may be here to stay. In the CPI, costs for health care services and health insurance continue to levitate and transportation services costs including motor vehicle fees, car insurance, and airfares remain elevated or are rapidly rising.

Higher costs for many services reflect ongoing labor shortages as Baby Boomers retire in industries requiring in-person work. This is more apparent in the PCE inflation data. Health care and health insurance costs are higher likely due to aging of the US population and labor shortages. Labor shortages contribute to consumer inflation via rising wages as labor costs remain one of the largest components in the companies’ cost structure. The costs of owning a vehicle are rising probably because cars are becoming more high-tech and thus, more expensive to maintain, repair, and replace. Housing insurance costs were already on the rise ahead of the recent wildfire outbreak in the West, and will continue to boost inflation as insurers will require higher compensation in light of the recent disasters. These dynamics are also evident in PCE inflation. These factors are resisting the Fed’s efforts to drive inflation back to the 2-percent target more quickly.