Inflation is not dead yet

Investors have been celebrating recent inflation data, which showed both consumer and producer prices rising by less than expected in October. But it would be wise not to get carried away by a single month’s numbers. As markets ponder the Federal Reserve’s next move, it’s too soon to be sure that the pace of monetary tightening can be safely scaled back.

Consumer prices rose 7.7% in the year to October, down from 8.2% in September and the peak of 9.1% June. The new rate is the lowest since January, before Russia’s war on Ukraine roiled global energy and commodity markets. Stripping out the cost of energy and food, so-called core CPI inflation is lower, and also falling — to 6.3% from 6.6% in September. The report made investors more confident that the Fed’s next hike in interest rates will be only 50 basis points, ending its recent run of 75-point increases.

A similar story prevailed with data released Tuesday. The producer price index rose by 8% from a year ago, the smallest annual gain in more than a year and less than the 8.3% economists had been expecting. It was up just 0.2% from the previous month, compared to an expected 0.4%.

All good news. But there are reasons for caution nonetheless. Inflation numbers are volatile and a short run of figures doesn’t make a trend. The slowdown in price increases was pretty broad-based, which is good, but it was helped by a sharp decline in the medical-insurance component, which was distorted by the pandemic. Before the Fed makes its next interest-rate decision in December, it will have another inflation report and new information on the state of the labor market to consider. Those will shed more light on whether the path of prices has indeed turned.

A different question then arises: How much further, as opposed to how quickly, should interest rates rise from now on? On this, the Fed has been less than explicit. Its most recent projections in September indicated a socalled terminal rate of about 4.5%, but Chairman Jerome Powell later sounded a more hawkish note, leading markets to expect a peak of roughly 5% in the middle of next year. Powell has said that a moderately positive real rate will be required. Supposing inflation falls to 4% by the middle of next year, and looks on track to fall gradually back to its 2% target, a terminal rate of 5% might then be about right.

The new figures make this gradual path to lower inflation plausible. This would be consistent with a slower pace of interest-rate increases from here on, as Fed Vice Chair

Lael Brainard suggested on Monday. With luck it could also allow the soft landing the Fed still hopes to engineer. But a lot has to go right for things to turn out so well. New supply-side shocks would change everything. Congress has to avoid throwing a spanner into the works. And despite the planned persistence of higher-than-target inflation through next year, price expectations will have to stay anchored - most likely requiring, in turn, a faster reduction of labor-market pressure on wages than seen so far.

For the moment, therefore, let joy be confined. The fight to control inflation has a long way to go.