Kiplinger Inflation Outlook: Better News May Not Last

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Inflation excluding food and energy (“core” inflation) dipped to 3.2% in December, though total inflation rose to 2.9%, due to a 4.4% pickup in gasoline prices. While the improvement in the core reading was welcome, further progress in reducing core inflation may be modest this spring and reverse in the second half of the year, leaving inflation a bit higher than it is now. On the positive side, shelter inflation continued at its new, lower level, and medical services costs rose by the smallest amount in four months. Going forward, shelter costs should contribute less to inflation than they have in the previous four years. New and used vehicle costs continued to rise, but these price increases should ease as inventories improve. The price of groceries rose by a moderate 0.5% in December.

Car insurance price increases have been modest for about three months now, after three years of a strong upward trend. The rise in health insurance costs has been more moderate this fall than earlier in the year. Car repair costs continue to rise at a strongish pace, however, and airfares jumped 3.9% in December.

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The Federal Reserve likely won’t put much weight on the improvement in the December report and will hold off on cutting rates at its January 31 policy meeting. While goods price increases have fallen back into a normal range, the Fed is worried about the strength in services inflation, because those tend to be persistent. Overall inflation rates should ease slightly in the first half of this year. But the drop in the headline yearly inflation rate will be a head fake that reverses in the second half of the year, even without any new tariffs on imports the new presidential administration is threatening. That is because the year-over-year reports in 2025 will be affected by the comparison month in 2024. Softer price gains in the latter half of 2024 will make the year-over-year comparisons look worse in the same period of 2025. That could curtail the Fed’s plan for future interest rate cuts.

While news headlines focus on the Consumer Price Index, note that the Fed’s goal of 2% inflation is based on a measure called the personal consumption expenditures deflator, not the CPI. The PCE deflator tends to run about a half percentage point below the CPI these days. The PCE deflator excluding food and energy rose at a 2.8% rate for the 12 months ending in November, compared with the core CPI’s 3.3%. This is a long way of saying that even the Fed’s preferred measure is showing that inflation is still too high.

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