The Federal Reserve May Have Reached Its 2% Inflation Target

Inflation Data Points to Progress

The PCE price index, which the Fed uses as its primary inflation gauge, has steadily declined over the past year. September’s consumer price index (CPI) and producer price index (PPI) also showed inflation easing. The CPI, which tracks retail price changes, came in at an annual rate of 2.4%, while the PPI, a measure of wholesale prices, registered at 1.8% year-on-year.

Chicago Fed President Austan Goolsbee expressed optimism about the progress, saying, “The overall trend over 12, 18 months is clearly that inflation has come down a lot, and the job market has cooled to a level which is around where we think full employment is.” Goolsbee added, “We’d like to get both of them to stay in the space where they are right now.”

Some Hurdles Remain

While the Fed is close to its inflation target, several challenges remain, particularly when it comes to core inflation. This measure, which strips out volatile food and energy prices, is considered a better gauge of long-term trends. For September, Goldman Sachs estimates core PCE inflation to be running at an annual rate of 2.6%. Using the CPI, core inflation is even higher, at 3.3%.

One of the primary drivers of higher core inflation is shelter costs, particularly rent. Fed officials expect shelter inflation to cool off over time as lower rent trends eventually make their way into the data. Fed Chair Jerome Powell addressed this issue on Sept. 30, stating that he expects housing inflation to continue easing and contribute to further disinflationary pressures in the broader economy.

Implications for Fed Policy

Lower inflation provides the Federal Reserve with the flexibility to continue cutting interest rates, especially as its focus shifts more toward the labor market. The central bank has already made an unprecedented half-point rate cut in September, lowering the federal funds rate to a range of 4.75% to 5%. This aggressive move was unusual for an economy in expansion, signaling the Fed’s commitment to managing inflation while balancing economic growth.

There is some debate, however, about how quickly the Fed should continue lowering rates. While a quarter-point rate cut in both the November and December meetings seems likely, Atlanta Fed President Raphael Bostic has expressed openness to pausing rate cuts altogether at the next meeting. Bostic’s concerns reflect the possibility that moving too quickly on rate cuts could reignite inflationary pressures, especially if consumer demand spikes again.

“Aggressive easing would risk spiking consumer demand just as it is settling into a sustainable pace,” noted PNC Senior Economist Kurt Rankin. Such an outcome could put pressure on businesses, driving up costs as they scramble to meet renewed demand.

What Comes Next

Futures markets are currently betting that the Fed will proceed with a quarter-point rate cut at both the November and December meetings, as inflation trends continue to move favorably. However, Fed officials will likely remain cautious, balancing the need to keep inflation under control while supporting a stable labor market and continued economic expansion.

As the Federal Reserve inches closer to its 2% inflation target, the coming months will reveal how quickly it will proceed with rate cuts and whether inflation remains on its current downward trajectory.