Stubborn inflation could prod Fed to keep rates high

Investors are giving up on dreams of imminent rate cuts as inflation remains stubborn, a problem that could prod Federal Reserve policymakers to keep borrowing costs high for a longer period.

The latest reading of the Fed's most closely watched inflation measure, released Friday, showed that price increases remain notably faster than the Fed's 2% goal.

The personal consumption expenditures index rose 2.7% in March from a year earlier, up from 2.5% in February. And after stripping out volatile food and fuel prices for a clearer reading of price trends, inflation remained steady at 2.8% on an annual basis.

The report was the latest sign that, after months of steady improvement in 2023, progress on cooling inflation is stalling out in 2024. And that unexpected roadblock has caused policymakers, economists and investors to question how soon and how much the Fed might be able to cut borrowing costs. Fed Chair Jerome Powell signaled last week that central bankers were not seeing the progress that they were hoping to witness before lowering rates.

The Fed meets next week in Washington to discuss its next rate move. While it is widely expected to leave interest rates unchanged in its decision on Wednesday, investors will watch a news conference with Powell closely for hints about how long rates are likely to stay on hold. If inflation continues to remain sticky in the months to come, it could prod officials to keep interest rates at their current relatively high level for an extended time as they try to tap the brakes on the economy and snuff out price increases more fully.

“There's a much greater uncertainty about the disinflationary path,” said Matthew Luzzetti, chief U.S. economist at Deutsche Bank, noting that “you're continuing to see an economy that's chugging along quite well.”

Policymakers raised interest rates to 5.33% between March 2022 and last summer, and have held them steady since. They think that is high enough to eventually weigh on the economy — in economics parlance, it is “restrictive.”

But some economists have begun to question just how restrictive the Fed's current rate setting is, because growth has remained solid and hiring rapid even after months of relatively high rates.

Data released Friday showed that momentum continued in March: Consumer spending rose 0.8% for the second consecutive month, ahead of forecasters' expectations. That spending is being supported by a strong market that is pushing up wages: Americans' after-tax income in March significantly outpaced price increases for the first time since December.

Separate data from a University of Michigan survey Friday showed that consumers had become slightly more pessimistic in April about the outlook for both the economy as a whole and inflation in particular.

Stock indexes rose Friday morning, in part because Wall Street had been bracing for a slightly worse inflation report after data released Thursday suggested that price gains might have been hotter in March than the personal consumption expenditure figures showed.

Friday's figures “could be viewed with a sigh of relief,” Omair Sharif, founder of Inflation Insights, wrote in a note following the report.