Inflation is toast — even if the Fed won’t say so yet

Inflation has cooled significantly — from more than 9 percent in June 2022 to 3 percent a year later — but central bank policy makers aren’t ready to declare victory.Justin Sullivan/Getty

Federal Reserve officials say they have no intention of lowering interest rates until they see convincing evidence that inflation is retreating back to their 2 percent target.

I’ve written a variation of this sentence most weeks since March 2022, when the Fed began pushing up lending rates in an effort to rope in runaway consumer prices.

Inflation has cooled significantly — from more than 9 percent in June 2022 to 3 percent a year later — but central bank policy makers aren’t ready to declare victory.

“There are promising developments, but given the continued strength in demand [for goods and services], my view is that it is just too early to take the recent improvements as evidence that inflation is on a sustained path back to 2 percent,” Susan M. Collins, president of the Federal Reserve Bank of Boston, said in a speech last week.

What’s next: The government releases its consumer price index report for August on Wednesday.

My colleague Jim Puzzanghera wrote over the weekend that forecasters expect the CPI to increase 3.6 percent from a year ago, the second month in a row the index has moved higher amid the jump in gas prices.

But so-called core CPI, a subset of the index that excludes volatile food and energy prices, is expected to drop to an annual 4.3 percent rate in August from 4.7 percent the month before.

So is inflation getting better or worse? To answer that question, let’s look at some of the price data the Fed weighs when making interest rate decisions.

Price indexes: CPI is the best known inflation benchmark, but the Fed’s preferred measure is the personal consumption expenditures index, or PCE.

Their differences help explain why the central bank leans more heavily on PCE.

CPI tracks direct spending by urban consumers, while PCE covers both urban and rural consumers and folds in purchases made on their behalf, such as prescription drugs bought by health insurers. Housing and energy carry more weight in the CPI, and health care is a bigger chunk of PCE.

And PCE items are updated quarterly to capture buying substitutions that consumers make in response to price changes. CPI is updated once a year.

Over the long term, CPI and PCE have yielded similar inflation readings.

Headline vs. core: PCE, like CPI, is reported in both overall (also called headline) and core versions. Economists, including those at the Fed, believe that stripping out food and energy prices provides a clearer view of underlying inflation trends. That’s because both categories are subject to sharp price swings that can distort broader price movements.

For example, in the months after Russia invaded Ukraine in February 2022 and energy prices soared, headline CPI jumped while core CPI was largely unchanged.

Over the past year the Fed has often divided inflation into three buckets: goods excluding food, where price gains are at or below 2 percent; housing, where rent increases are high but moderating; and services excluding energy and shelter, where scant improvement is a big reason the Fed remains cautious.

Inflation expectations: Where consumers and businesses see inflation headed is a key indicator. If the public thinks costs are going to rise, workers will seek higher pay to keep up. Businesses, in turn, are likely to boost prices to cover higher costs.

While inflation expectations are above the Fed’s comfort level, they have not spiraled out of control and are now on the decline.

Employment: The Fed has been hyperfocused on the job market. Employers have pared back hiring for months, but policy makers believe demand for workers continues to outpace supply. They argue that inflation won’t fall back to 2 percent unless job creation weakens even further and the unemployment rate climbs.

What to remember: While the headline CPI number for August could seem like a step in the wrong direction, it’s just one of many pieces of data that together form the inflation picture.

Moreover, when looking over longer periods than a month or two, the economic trends remain positive. Most forecasters expect inflation will continue to wane — slowly but convincingly — even as the economy grows.

“The resilience I see leads me to believe price stability is achievable with an orderly slowdown and only a modest unemployment rate increase,” the Boston Fed’s Collins said last week.

The Fed is being particularly prudent because, you know, no one wants a reckless central bank. The fight against inflation is all over except the shouting.