Forecasts for January CPI Report Point to Slow Progress In Inflation Fight

Forecasts for January’s Consumer Price Index report show inflation continuing to slow.

The data will come on the heels of a red-hot January jobs report and a concerted effort by the Federal Reserve to let financial markets know that it isn’t declaring victory on inflation—yet.

Economists expect the overall CPI reading to come in at 2.9% on an annual basis in January, down from 3.4% in December, according to FactSet’s consensus estimates. Economists are expecting 0.2% growth on a monthly basis in January, the same pace as in December.

Investors will be watching the report closely when it is released at 8:30 a.m. EST on Tuesday for signs of progress on the so-called “last mile” in the Fed’s inflation fight. Market participants have dramatically reduced their expectations for a rate cut at the central bank’s meeting in March, but futures prices indicate investors still see more than a 50% chance of a cut in May. Tuesday’s data will be a critical piece of the puzzle.

January CPI Forecast Highlights

• The CPI is forecast to rise 0.2% in January after rising 0.2% in December, according to FactSet.
• Core CPI is forecast to rise 0.3% in January after increasing 0.3% in December.
• The CPI year over year is forecast to rise 2.9% in January after increasing 3.4% in December.
• Core CPI year over year is forecast to rise 3.7% in January after rising 3.9% in December.

CPI growth in January is likely to “continue to trend in the right direction,” says Katie Nixon, chief investment officer at Northern Trust Wealth Management. “I don’t expect any huge surprises next week … just progress.” However, she adds that this progress will likely be slower compared to declines in PCE inflation, which is the Fed’s preferred measure of price growth. But overall, “we do anticipate that inflation is going to come down.”

At UBS, economists forecast the CPI to rise by less than 0.1% in January, with a 0.2% increase excluding food and energy: “We project Tuesday’s CPI release to show the headline CPI rose 0.08% in January, as falling gasoline prices once again will likely hold the headline price increase below the core increase.”

Within the core CPI, “We expect a number of components will rise faster in January than in the past couple of months,” the UBS team wrote. “That broader uptick, however, is obscured by an almost 4% decline in used car prices that is contributing 0.12 percentage point less to the core CPI monthly change in January than it was in December.”

Housing and Services Inflation Are Slower to Fall

While inflation is broadly declining, the story is more mixed under the hood.

Economists at Bank of America are calling for a “good enough” report: “Disinflation has been driven more by goods price deflation, while services disinflation has been more stubborn. We expect this divergence to persist in January.” They forecast core goods prices fell by 0.3% month over month in January while core service increased by 0.5%. Overall they forecast a 0.2% increase in the CPI for January and a 0.3% increase excluding food and energy.

The Bank of America team expects a drop in used car prices to drive down core goods inflation: “Services are likely to be boosted by larger price increases in transportation services and lodging away from home this month as demand for travel started the year on a strong note ... In addition to the few volatile items, shelter is the other reason that core services inflation has remained stickier. The good news is that we expect shelter inflation to moderate over the course of the year, given the disinflation seen in asking rent inflation.”

Jeffrey Roach, chief economist at LPL Financial, notes that some components of inflation move quicker than others. Changes in energy prices and durable goods show up quickly in the government’s headline number, while housing costs like rents tend to lag. “You’re going have kind of a delayed reaction on certain categories,” Roach says, such as services and rent prices. “The last mile is up to those most sticky categories.” Analysts across the board expect rent inflation to fall in the coming months.

Prices for goods, on the other hand, have fallen quickly enough to pull headline inflation down over the past few months. “It’s been this push/pull,” Nixon says. “We get progress on the goods side, we see more inflation coming from the services side.”

Labor Market Strength Means More Stubborn Inflation

Those sticky prices for services are in large part attributable to ongoing strength in the labor market, which has remained robust despite the Fed’s aggressive tightening of monetary policy.

“You’re seeing real wage gains that are pretty substantial, and that is encouraging consumption, which drives economic activity, which drives labor demand, and that’s the loop that [Federal Reserve Chair] Powell is worried about,” Nixon says. In other words, people with jobs spend money, and that spending could drive up prices. Last week’s blockbuster jobs report was a “wakeup call that we’re not quite done yet with that last mile of inflation,” according to Nixon.

Risks to January’s Inflation Outlook

January could also bring more inflation on the goods side of the equation, Nixon says, thanks to rising manufacturing costs. It’s a sign that the price declines that have dragged inflation lower might be coming to an end. “We do have to be mindful that the goods area might start to tick up again, and that’s going to create a little bit more of a tailwind [for inflation] versus the headwind,” she says.

Analysts are also monitoring ongoing unrest in the Red Sea, which is driving up shipping prices. “The supply chain story is going to be front and center,” Roach says. Those challenges “could be a headache for policymakers in the near term.”

When Will the Fed Cut Rates?

Powell has been adamant in recent weeks that while the Fed is seeing good progress on inflation, it’s not likely that the central bank will cut interest rates at its March meeting.

“The job is not done,” Powell said in an interview with 60 Minutes earlier this month. “We want to see more evidence that inflation is moving sustainably down to 2%.” The Fed’s decision-making committee expects to see that evidence and cut rates at some point this year—the only question is how soon.

According to the CME FedWatch Tool, which measures expectations for the federal-funds rate based on trading in futures contracts, the Fed has a 52% chance of cutting interest rates by a quarter point in May, while there’s a 39% chance of rates holding steady.

“A report in line with our expectations would continue to build the Fed’s confidence and support our expectation for the first cut to be in June,” Bank of America economists wrote. “The details of our forecast suggest that January PCE inflation, the Fed’s preferred measure, could come in softer than CPI again given the difference in weights for housing services. That said, strong PCE financial services inflation may bias the print higher in January. Nevertheless, this is just the first of five CPI reports the Fed will have on hand at its June meeting. Therefore, the outcome of the January report is unlikely to meaningfully shift our expectations for monetary policy.”