Headline CPI Inflation Held Firm in September. But the Fed’s Work Isn’t Done.

The core index, which strips out volatile food and energy prices and is considered a better gauge of underlying inflation, was in line with expectations and offered a slightly more hopeful story. Core prices climbed 0.3% in September, matching the previous month’s pace, and slowed to a 4.1% annual rate from August’s 4.3%.

Continued disinflation in the core measure will come as welcome news to the Fed, and suggests that the central bank’s efforts to slow the economy—primarily by raising the federal funds rate to a range of 5.25% to 5.5%—are having an impact. The slowdown has been abetted by rising bond yields and tightening financial conditions, which recently prompted comments from various Fed officials who feel the market is doing some of Fed’s work in reining in growth. 

Against that backdrop, September’s inflation data suggest the Fed is likely on track to hold interest rates steady when officials meet again on Oct. 31-Nov. 1. After the data’s release Thursday morning, investors were pricing in a nearly 90% chance that rates will remain unchanged at the current level through November.

“This CPI report will undoubtedly keep Fed officials on high inflation alert, but it won’t tilt the FOMC toward another fed funds rate hike at the upcoming meeting,” EY-Parthenon chief economist Gregory Daco wrote Thursday.

But there could be further policy tightening after the November meeting. The details of the September report reflected enough strength left in price growth that the possibility of a December interest-rate hike is still on the table.

Shelter costs, for one, are remarkably strong, and were the largest contributor to overall price growth in September. Rent costs climbed 0.5% for the second straight month, while an equivalent measure for homeowners’ rent rose 0.6% after increasing 0.4% the month before. Hotel costs also jumped significantly, rising 4.2% in September after falling 3.6% in August.

Fed officials pay close attention to the shelter index partly because it makes up more than 40% of the overall core index and therefore has major sway over the direction of core price growth. While housing traditionally has been sensitive to rate hikes, persistent demand and lack of supply have both kept the market more elevated than most economists anticipated when the Fed first began raising rates. 

Some Fed officials have warned that, as a result, the long-awaited slowdown in shelter inflation could be shorter-lived than previously anticipated.

Core services beyond shelter have garnered even closer attention from the Fed in recent months. September’s data offered little to like. Core services excluding rent and the owners’ equivalent measure came in at 0.6% in September, up from 0.4% in August and reached the highest level in a year, according to calculations from Ian Lyngen, rates strategist with BMO Capital Markets.

That figure reflected strength in services categories across the board. Medical care services accelerated to 0.3%, from 0.1% last month. Recreation services climbed 0.5% after declining 0.1% in August. Transportation services decelerated from August, primarily reflecting a slowdown in airfares, but still climbed 0.7% for the month.

Overall, the report highlights just how stubborn price growth remains even despite the Fed’s 11 interest-rate increases so far. 

“This report showed less progress on inflation than was hoped for and is consistent with the view that the last mile on inflation to the Fed’s 2% target will be on a bumpier path,” wrote Richard de Chazal, macro analyst with William Blair.

The outlook for further deceleration in inflation is also growing cloudier. 

Oil prices could prove volatile in the coming weeks, due to the impact of the Israel-Hamas war. Used car prices might stop declining, and other goods prices are more or less holding steady. 

Health-insurance costs are also all but guaranteed to begin rising in October’s data, due to a looming recalibration in sector prices. That adjustment will erase the impact of a Covid-era anomaly that had been making health-insurance inflation appear artificially low and push overall price growth up.

The labor market also is holding strong, suggesting the economy will be able to withstand further tightening if needed.

Overall, the persistent strength in both price growth and the labor market suggests that while the economy appears to be headed back toward equilibrium, there might well be room for further action from the Fed to ensure the slowdown continues. 

“The strong labor market means that the threat of inflation resurgence cannot be ignored, keeping the Fed on its toes,” wrote Seema Shah, chief global strategist with Principal Asset Management. “The question around whether or not there will be one more interest interest-rate hike is yet to be answered.”

Write to Megan Cassella at [email protected]