Fed’s Kugler Expects Inflation Will Keep Cooling, Making Way for Rate Cuts

Federal Reserve Gov. Adriana Kugler said Wednesday that her baseline expectation is that inflation will continue to diminish without a broad economic slowdown, which would allow for rate cuts this year.

In remarks prepared for an event hosted by Washington University in St. Louis, Kugler said that she expects the rate of inflation to keep falling despite the “firmer” results recorded for January and February. “If disinflation and labor market conditions proceed as I am currently expecting, then some lowering of the policy rate this year would be appropriate,” Kugler said.

The Fed’s preferred inflation measure, the core personal consumption expenditures price index, rose 0.3% from a month earlier in February and 0.4% in January. In February, PCE inflation rose by 2.5% compared with a year prior, compared with the revised rate of 2.4% rate logged in January and the 2.6% increase in December.

But Kugler noted the January numbers, in particular, featured some “atypical or seasonal factors that suggest a need to withhold judgment.”

Looking ahead, Kugler said she expects growth in consumption to slow some this year. “Households have drawn down large balances of excess savings accumulated during the pandemic and are facing restrictive financial conditions,” she said. “We may already be seeing some of that slowing.”

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With less consumer spending, Kugler believes, gross domestic product growth this year will be solid, but slower than last year’s strong 3.1% pace. Yet even with demand growth cooling, Kugler said her baseline expectation is that “further disinflation can be accomplished without a significant rise in unemployment.”

To be sure, geopolitical problems, such as the wars in Europe and the Middle East, do present risks to Kugler’s economic outlook of cooling inflation and solid GDP growth. But she discounted any widespread economic effects from the recent bridge collapse in Baltimore, saying it appears that shipping networks are adapting.

With regard to inflation, Kugler noted that gains in the cost of goods have cooled quickly, noting that supply-chain pressures, in particular, have eased “considerably”—though perhaps not completely. Goods prices in February, for example, were trending much lower than the levels recorded a year ago, Kugler said.

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Services inflation, however, peaked later and has cooled less quickly, Kugler noted. The service sector tends to be heavily influenced by labor dynamics. And while the labor market is coming back into better balance, it hasn’t entirely returned to normal. That move toward a better balance between the supply of workers and demand has helped cool wage growth, Kugler said, which means gains in operational costs in the services sector have slowed and eased inflationary pressures.

Kugler did note that housing inflation, in particular, continues to be higher. The cost of housing registered a year-over-year increase of 5.8% in February, though that was down from the rate of more than 8% seen in early 2023. Kugler says this is to be expected, to some extent.

“Housing services inflation is naturally persistent because tenant rents often have year-long lease agreements, and estimates of owner-occupied housing costs are imputed based in large part using those tenant rents,” she said, adding that “continued disinflation will indeed require further progress in housing and non-housing services.”

Write to Megan Leonhardt at megan.leonhardt@barrons.com

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