How the New Inflation Numbers Could Affect When the Fed Cuts Rates This Year

Inflation ticked up in February, which could give Federal Reserve officials more reason to be cautious as they think about potentially easing interest rates.

The Federal Reserve’s rate-setting committee is in the spotlight, given forecasts for an interest rate cut sometime in the coming months. Lower rates could give momentum to key parts of the economy, like the real estate market, currently in a slump due to high mortgage rates.

Analysts say inflation has made an impressive descent from the June 2022 peak above 9% to the current annual rate of 3.2%, per the latest consumer price index (CPI) report. But the February increase from last month's inflation rate of 3.1% is a reminder that getting to the Fed’s target of 2% inflation could take time, according to Skyler Weinand, chief investment officer at Regan Capital in Dallas.

“With inflation coming in slightly hotter-than-expected, we think it’s a coin flip as to whether the Fed cuts interest rates in June or if it takes a more conservative approach and waits until September. The last mile of price stability is proving to be the hardest,” Weinand said in a note.

When will the Fed cut interest rates?

Last week, Federal Reserve Chair Jerome Powell said during congressional testimony that “it will likely be appropriate to begin dialing back policy restraint at some point this year” assuming that the “economy evolves broadly as expected.” However, higher-than-expected inflation could delay rate cuts — possibly even until next year in a worst-case scenario.

If inflation declines in the months ahead, the Fed will likely look to cut rates. Bank of America economists concur with the prevailing expectation among investors for interest rate cuts beginning in June, noting that softening of services inflation in the February CPI report is a positive development.

Lydia Boussour, a senior economist at consulting firm EY-Parthenon, thinks that “Fed officials will likely put this inflation report in the ‘not so good’ column.” Still, EY is forecasting multiple rate cuts later this year.

“While the path may prove bumpy, we expect inflation will continue to move lower in coming months,” Boussou said in an analysis of the CPI report. “As such, we see the Fed policy easing cycle starting in June.”

Beyond the headline inflation number, there were some positive aspects of the inflation report from an investing perspective, experts said. The monthly increase for owners’ equivalent of rent (OER), which tracks housing inflation for owners, dropped to 0.4% from 0.6% in January. (January's high OER has been a concern among analysts.)

Also, some of the CPI inflation for the month of February can be blamed on rising gas prices, which are not of much importance to the Fed. The Bureau of Labor Statistics noted that shelter and gas combined caused more than 60% of the 0.4% CPI inflation for February. Other categories that contributed to the month’s inflation were airfare, car insurance, apparel and recreation.

Overall, Jeffrey Roach, chief economist for LPL Financial, said it was unclear if the inflation report would be viewed as positive or negative. “Expect to see markets struggle with what this means for Fed policy," Roach said. Stocks rose Tuesday with the S&P 500 up about 1% by mid-afternoon.

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