Cooling Inflation Could Pave The Way For Fed Rate Cuts

The sudden drop of inflation in November could clear the decks for the Federal Reserve to cut interest rates to help boost the faltering job market. But the outlook is complicated by the government shutdown’s impact on the data.

Core inflation in the Consumer Price Index fell to a four-year low in November, the Bureau of Labor Statistics said Thursday. Normally that kind of news would be music to the ears of officials at the Federal Reserve who adjust the central bank’s interest rate with the goal of keeping inflation low. If the trend is confirmed in future months, the central bank might cut interest rates without fear of stoking inflation.

However, experts said the good news could prove to be a mirage, since the government shutdown in October and November may have distorted the picture. Among other abnormalities, the BLS did not report price data for October at all, since it couldn’t carry out its usual surveys that month.

Economists have long expected inflation to cool significantly because home prices have decelerated over the past few years after surging during the pandemic. That day may have finally arrived, which could help resolve the debate among Fed officials about whether to keep the fed funds rate higher for longer to fight inflation. Alternatively, they could lower it to boost the economy and encourage hiring to prevent the recent jobs slowdown from turning into a wave of high unemployment.

“A surprisingly sharp decline in U.S. consumer price inflation should grease the wheels for further Fed easing in 2026,”  Sal Guatieri, senior economist at BMO Capital Markets, wrote in a commentary.

Financial markets are pricing in only a 26.6% chance the Fed will cut interest rates at its next meeting in January, after it cut them by a quarter-point at each of its last three meetings. Thursday’s surprisingly tame inflation report did little to shift those expectations. Fed officials may wait for more reliable data before making any more moves with interest rates, since setting rates too low risks fueling high inflation.

“The latest CPI numbers are encouraging for the Federal Reserve, but Fed Chair Jerome Powell has already warned against reading too much into the latest data due to distortions from the shutdown,” Bernard Yaros, lead economist at Oxford Economics, wrote in a commentary.

Still, the report could help ease some inflation concerns at the Fed, which has a dual mandate to keep inflation low and employment high. Data this week showed the job market’s recent slowdown deepened in November, which could encourage the Fed to emphasize the labor side of its mandate and make rate cuts more likely.

“The weaker than expected inflation reading for November supports the case for further Fed cuts in the New Year, particularly given the deterioration in labour market conditions signaled by data released earlier this week,” Andrew Grantham, senior economist at CIBC, wrote in a commentary.