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Economic and Market Commentary

U.S. Inflation Eased More Than Expected in November as Fed Eyes Pause in Rate-Hike Cycle Next Year

A slowdown in the pace of U.S. inflation in November reaffirms our view that the Federal Reserve will pause its rate-hike cycle in early 2023.

The Labor Department said CPI (the U.S. Consumer Price Index) rose 7.1% in November year-over-year (y/y), better than the consensus estimates of 7.3%, and down from 7.7% in October. The long-awaited moderation in inflationary pressures across consumer goods categories should be relief for Fed officials, since it helps alleviate the risk of rising inflation expectations. Nevertheless, the underlying pace of inflation still looks inconsistent with the Fed’s target – the stickier categories remained sticky – and will likely prompt the Fed to continue with additional rate hikes for now.

We expect the central bank will raise its target for the federal funds rate by a half-point at the December meeting to 4.25%–4.5%, with another increase early next year that will take the rate to just below 5%. From there, the Fed will likley pause and assess the economic effects of its tightening to date. If the economy weakens and inflation moderates, its next move will likely be down.

Lower prices for core goods, healthcare, and travel

In November, core goods prices declined 0.5% month-over-month (m/m) on a large drop in used car prices, which also began to pressure new car prices. Higher inventories, improved production of new cars, and a dearth of fleet purchases by rental car companies contributed to declines. Overall, retail used car prices in the CPI appear to be slowly catching down to price declines in the wholesale market, while vehicle replacement demand was smaller than many expected in the aftermath of Hurricane Ian.

Prices for retail goods weakened after holiday discounting from Amazon and other retailers, although November’s Black Friday reductions were in line with seasonal averages. Electronics and recreational goods fell 0.4% m/m, consistent with larger-than-usual seasonal discounting.

Healthcare insurance prices dropped once again, and this new pace should contribute to more moderate inflation in the broader healthcare category over the next year. The normalization in insurance company margins is now subtracting 3 basis points (bps) off headline m/m inflation, after adding a similar amount in 2022.

The pace of inflation in services also slowed to 0.4% m/m as prices for airfares and lodging fell. Lower jet fuel prices continued to be passed through to airfare prices (-3.0% m/m). Hotel prices also continued to be volatile (-0.9% m/m after surging in October), and some of this noise is likely reflecting changing preferences and corporate travel patterns during the pandemic.

Higher prices for housing and “sticky” sectors

Importantly, rents and owners’ equivalent rent (OER) reaccelerated and continued to run at elevated levels of 7.9% y/y and 7.1% y/y, respectively; this compares to a pre-pandemic trend of increase of about 3%–3.5% y/y. Although other data show a notable cooling of rental prices and OER over recent months, we don’t expect this will be reflected in CPI until late 1Q or early 2Q next year. We expect OER will maintain a roughly 0.7% monthly pace until then.

Smaller service categories also pointed to “sticky” inflation in light of still-elevated wage inflation. Categories such as personal services (up 0.8% m/m), education services (up 1% m/m), and recreation services (up 1% m/m) all reaccelerated from October.

Higher prices for apparel (up 0.2% m/m) and household furnishing (up 0.4% m/m) muted the usual holiday discounting cycle, but we expect prices will soften across retailers as inventory-to-sales ratios have fully recovered, while consumer demand for goods continues to downshift after a post-pandemic boom.

Fed forecasts

In sum, today’s data should be a relief for Fed officials and takes some pressure off them to further restrict the economy. Indeed, when the Fed releases its new rate path forecasts in the Summary of Economic Projections at the December meeting, we think the rise in the median rate path forecast is going to be more muted now that we’ve seen two softer CPI reports in a row. Although Fed Chair Jerome Powell has guided that forecasts are likely to once again rise, this report raises the risk that they don’t and the Fed could very well be cutting later next year.

Please visit our Inflation and Interest Rates page  for further insights on these key themes for investors.

Tiffany Wilding and Allison Boxer are economists and regular contributors to the PIMCO Blog .

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