January inflation strikes again

Consumer prices rose 0.5 per cent in January from December, lifting the annual rate to 3.0 per cent and reminding markets that the start of the year is a bad time to bet on calm inflation. Traders who had positioned for a smooth descent to the Federal Reserve's two per cent target had to unwind their bets on rate cuts in a hurry.

Core prices joined in

The detail was worse than the headline. Core prices, which exclude food and energy, rose 0.4 per cent on the month and 3.3 per cent on the year, so the jump cannot be blamed on petrol or on eggs, whose price was pushed up again by bird-flu culls. The report landed on the second day of Jerome Powell's testimony to Congress, in which the Fed chairman had already said the central bank was in no hurry to cut. Treasury yields rose sharply on the release, and futures markets pushed back the date by which they expected the next cut.

The biggest contributors were the ones that reset annually. Car insurance, which is repriced at each renewal and has been chasing higher repair and replacement costs for two years, rose sharply again. Used-car prices and airfares, both volatile, added to the monthly figure. Shelter, the largest single component, kept rising at a pace that the latest rents on new leases no longer justify, a lag that should eventually pull inflation down but has been slow to arrive.

Every January, new price lists

January has long run hot, because it is when service contracts, healthcare reimbursement schedules, postal rates and software licences reset. Pricing managers, used to years of tolerance for inflation after the pandemic, took the new year as a chance to pass on the cost increases they had been sitting on. That stickiness in core services outside housing suggests companies have not gone back to the pricing habits of the low-inflation years before 2020.

Wages and benefits reset at the same moment. Many states raised their minimum wages on January 1st, and Social Security payments rose by 2.5 per cent under the annual cost-of-living adjustment. Neither is a price in the CPI basket, but both put more cash in the hands of lower-income households just as firms publish new price lists, which makes it easier for those prices to stick.

The statistical problem compounds the economic one. Seasonal adjustment is supposed to strip out predictable calendar effects, but it estimates them from past years, and the price resets that followed the pandemic were larger than anything in the earlier record. January 2024 also brought a hot reading, and the first-quarter scare that followed had faded by the summer, which suggests the adjustment has not yet caught up with how companies now set prices.

The case for patience

There is a respectable argument that January overstates the trend. The Fed targets the personal consumption expenditures index rather than the CPI, and that measure gives less weight to housing and draws some components, such as airfares and portfolio management fees, from producer prices. The translation into PCE terms can therefore be gentler than the CPI headline suggests. If February and March come in near the pace of late last year, the January reading will look like noise.

The producer-price report released the day after the CPI partly supported that view. The headline was also hot, but the components that feed into the PCE index were softer than feared, and forecasters trimmed their estimates of January's core PCE accordingly. That is a thin cushion. It moves the problem from alarming to merely stubborn, and leaves core inflation on the Fed's preferred gauge well above target more than two years after the peak.

Rate cuts go on hold

For the Federal Open Market Committee, the pick-up in monthly core inflation removes the case for back-to-back rate cuts. Policymakers can hardly dismiss a start-of-year spike as seasonal noise when the labour market is tight and proposed tariffs threaten to push costs higher. The Fed has already lowered its policy rate by a full percentage point since September, to 4.25–4.5 per cent, and paused in January, so it can afford to wait for more evidence.

History argues for that caution. In the 1970s the Fed repeatedly eased as soon as inflation dipped, only to see it return higher each time, and the credibility lost in those years took a deep recession under Paul Volcker to rebuild. Today's officials cite that record often. They would rather keep rates too high for a few months than be seen to declare victory and then reverse course.

The cost of waiting falls on borrowers. Mortgage rates remain close to 7 per cent, credit card rates stay near record highs and companies refinancing floating-rate debt get no relief. Savers in money-market funds, by contrast, keep collecting yields above the inflation rate for longer. Holders of inflation-protected Treasuries gain too, since their principal is indexed to the very CPI that surprised.

Dates to watch

The January PCE figures arrive at the end of February, and the Fed next meets in mid-March with fresh projections. A second monthly reading of core inflation at 0.4 per cent would turn a calendar quirk into a trend and could take cuts off the table for much of the year. Tariffs add a separate upside risk, since duties already imposed on Chinese goods and those planned on steel and aluminium will start to show up in goods prices within months.

Household expectations are the other gauge. The University of Michigan's survey has shown consumers' expected inflation rising in recent readings, with many respondents citing tariffs. That matters because households that expect higher prices buy ahead and accept increases more readily, which is how a one-month jump turns into a second year of sticky inflation.

The lesson from recent Januaries is that price resets have become a habit. Companies still have enough pricing power to raise prices when the calendar lets them, and the Fed will probably hold rates where they are until the spring data show the January jump was a one-off, which leaves the March meeting a near-certain hold and pushes the first plausible cut to the summer.