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The Euro to Dollar exchange rate rallied to eight-month highs after Bureau of Labor Statistics data showed U.S. inflation easing for a third month running while providing a tentative indication of a possible victory for Federal Reserve (Fed) interest rate policy being in the pipeline.
Europe's single currency climbed briefly above 1.08 against a falling a Dollar on Thursday after the Bureau of Labor Statistics said the annual inflation rate had fallen from 7.1% to 6.5% in a December decline for which gasoline and fuel prices were largely responsible.
But far more noteworthy was the extent to which shelter prices - housing costs - were responsible for keeping inflation from falling further in December after adding 0.8% to the consumer price index at year-end.
This is important because inflation of shelter prices is a mere temporary side effect of the Federal Reserve (Fed) interest rate response to other forms inflation, and one that Federal Open Market Committee members are likely to take account of when setting policy in the months ahead.
"With the shelter sub-index softening ahead, and the impact of past interest rate hikes materializing more, the Fed will likely be able to pause after a final 50bps hike at the next FOMC," writes Katherine Judge, an economist at CIBC Capital Markets, following a review of the data.
Above: Euro to Dollar rate shown at 15-minute intervals. Click image for closer inspection.
Thursday's price developments are all the more important after Chairman Jerome Powell said twice in December that Fed officials would likely overlook inflation in housing costs to focus instead on the pace of price growth in other parts of the services sector over the coming months.
"As rents expire and have to be renewed, they’re going to be renewed into a market where rates are higher than they were when the original leases were signed," he said in December's monetary policy press conference.
"But we see that the new leases that are—that the rate for new leases is coming down. So, once we work our way through that backlog, that inflation will come down next year," he added.
What's more, the services sector inflation rates that actually matter were some of lowest or weakest of all those reported in Thursday's data with transportation and medical services inflation coming in at 0.2% and 0.1% respectively.
Put differently, the services sector inflation reported on Thursday was not inconsistent with the Fed's overall inflation target.
Many economists, however, doubt this will keep the Federal Open Market Committee from raising interest rates further.
Source: Bureau of Labor Statistics. Click image for closer inspection. If you are looking to protect or boost your international payment budget you could consider securing today's rate for use in the future, or set an order for your ideal rate when it is achieved, more information can be found here.
"The ‘core’ services CPI ex-rent measure that has been dubbed as the best gauge of underlying price pressures by Chairman Powell has also continued to show signs of improvement, averaging around just under 3% (annualized) for the last quarter," says Claire Fan, an economist at RBC Capital Markets.
"Federal Reserve officials will still be wary about easing financial conditions on top of extremely heated labour markets conditions and elevated wage growth. We expect a 25 bp increase in the Fed Funds target in February to be followed by another one of the equal size in March, before the Fed pauses for a reassessment," Fan writes in a research review.
The Fed's updated forecasts suggested in December that its interest rate could be lifted to anywhere between 5% and 5.5% this year after being raised to 4.5% last month; a 425 basis point increase from 0.25% in March 2022.
Meanwhile, minutes of December's meeting told of how rate setters had frowned at market pricing of interest rate cuts for later this year and indicated a desire to prevent financial conditions from loosening through declines in the U.S. Dollar and bond yields and increases in stock markets.
"There is a clear bias for the market to fight the Fed (terminal rate expectations have stuck steadfastly around 5% despite Fed hawkishness)," says Skylar Montgomery Koning, a senior macro strategist at TS Lombard, whose forecasts envisage U.S. interest rates being cut to 2.75% by year-end.