US CPI inflation: 2% target out of reach for now

Inflation remains sticky: Today's inflation data support our view that inflation will remain above target throughout this year, preventing the Fed from cutting interest rates. The headline consumer price index (CPI) rose by 3.0% yoy (0.5% mom) in January, above the 2.9% (0.3% mom) both Bloomberg consensus and we expected. The core CPI, which excludes food and energy prices, rose by 0.4% mom, pushing the year-over-year rate up from 3.2% in December to 3.3% in January (consensus: 3.1%, Berenberg: 3.3%). After the CPI release, the futures and swaps markets postponed the next Fed rate cut from September to December, and the 10-year Treasury yield rose by nearly 10bp. The Fed has made it clear that they need “continued progress on inflation” to consider rate cuts, assuming the labour market remains near full employment. They also need to regain confidence that the inflation trend is moving downward. Although disinflation in shelter and non-market-based services can help build this confidence, the Fed cannot ignore Trump. Even without deportations and tax cuts, the tariff-induced rise in goods inflation could more than offset disinflation in services.

Inflation reacceleration?: Recent macroeconomic data have added to the Fed's concerns that inflation risks are tilted to the upside. 15 of the 19 Fed staff expressed such concerns in the December economic projections already. Since then, more businesses have been reporting higher input prices. The ISM index for services prices paid reflects this, recording readings above 60 over the past two months – the highest consecutive readings since February 2023, when core inflation was running around 5% yoy. The January nonfarm payroll report provided further evidence of rising input costs for firms, with wage growth coming in at 0.5% mom, surpassing the consensus expectation of a 0.3% increase. Additionally, the latest survey data revealed that long-term consumer inflation expectations are “less anchored” than before the pandemic.

Tariffs will add to price pressures: Perhaps even more concerning are signs of an overheating economy emerging even before president Trump has implemented new tariffs. The Boston Fed estimates that core PCE inflation could be 0.5-0.8ppt higher if the 10ppt hike in tariff rates on China remain in place and Trump un-pauses the 25% tariffs on Mexico and Canada. And in our view, this is an optimistic estimate, as opportunistic pricing and rising inflation expectations could further push up inflation. In conclusion, upside inflation risks are high, and the Fed is aware. One of the most dovish voting members on the Fed, Austan Goolbee from the Chicago Fed, said last week: “Now we’ve got to be a little more careful and more prudent about how fast rates can come down because there are risks that inflation is about to start kicking back up again.”

Atakan Bakiskan

US Economist

+44 20 3207 7873

atakan.bakiskan@berenberg.com

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