February inflation moderates

What happened?

Core inflation in the US in February came in at 3.1% year-over-year, its lowest level since the start of the inflationary surge in 2021. After the past several years of eye-catching inflation data, inflation has moderated significantly, with 10 straight months now below 3.5%.

Progress toward the Fed’s 2% inflation goal has slowed in recent months, making this month’s data somewhat encouraging as it suggests progress continues, even if slowly and inconsistently.

Shelter inflation moderated slightly, down to 4.2% from 4.4% last month, and a new low for the cycle. We continue to anticipate further declines in that measure, which are arguably the most important trend in the data as shelter is one-third of consumption and has been the source of this inflationary cycle’s persistence.

Part of the improvement in inflation, though, did come from more volatile segments which may reverse in the coming months, such as airfares and auto prices, suggesting that momentum may fade. Finally, after a year of outright deflation in goods prices, they are now flat year-over-year and, with the introduction of tariffs, we expect to see rising goods prices in the coming months. The breadth and magnitude of those price increases will depend on the tariffs actually enacted. The pressure from tariffs will make ongoing progress in reducing shelter inflation that much more important to the underlying trend.

Policy implications

This latest inflation report suggests the Federal Reserve will be able to maintain its current stance of a bias toward further cuts, but at a gradual pace based on incoming data. Chair Powell and others on the FOMC have spoken about that strategy in recent remarks and February’s inflation data support the prudence of that approach.

For an accelerated pace of cuts, the Fed will have its eye on the labor market, which has remained steady. A slower pace of cuts would require a resurgence in inflation, above and beyond any price increases coming from tariffs. Policy uncertainty looms over the labor market and appears to be seeping into corporate planning; however, that hasn’t manifested in the data yet. Chair Powell’s Fed has been extremely data-driven and has not attempted to preempt incoming datapoints. We don’t expect them to start now.

We continue to expect the Fed to reduce rates over the course of the year from 4.25%–4.5% today to 3.5%–3.75% by the end of the year. That remains roughly in line with consensus, which currently anticipates rates ending the year at 3.5%.