The Fed’s Preferred Inflation Gauge Cooled in August

Inflation is slowing so much that some economists said it could pave the way for another big Fed rate cut, if other data suggest one is warranted.

Inflation cooled in August, the latest sign of progress in the Federal Reserve’s yearslong fight to bring rapid price increases back under control.

The Personal Consumption Expenditures index climbed by 2.2 percent from a year earlier, data released Friday showed. That is down from 2.5 percent in July and slightly softer than economist forecasts. It was the slowest annual inflation reading since early 2021.

After stripping out volatile food and fuel prices for a better sense of the underlying inflation trend, a “core” price index was a bit more stubborn on an annual basis. The core measure came in at 2.7 percent, up from 2.6 percent previously and in line with what economists had expected. But comparing prices from month to month, core inflation slowed to a modest 0.1 percent in August.

Altogether, the report offers further proof that price increases are swiftly fading. Already, that has allowed the Fed to begin to lower interest rates from a more than two-decade high of 5.3 percent. After raising borrowing costs sharply and then holding them at a high level to slow the economy and weigh down inflation, officials voted last week to cut rates by a larger-than-usual half percentage point. Policymakers also signaled that more rate cuts are coming, as long as inflation continues to fade.

“It’s exactly the kind of evidence they want to see,” Omair Sharif, founder of Inflation Insights, said of Friday’s report, adding that the fresh data “clears the runway” for the Fed to lower interest rates relatively quickly.

The Fed’s pivot toward rate cuts is already helping to bring down mortgage rates, and it could slowly trickle through the economy to stop the job market from slowing more markedly. Central bankers are trying to pull off a rare “soft landing,” in which they cool conditions enough to wrangle price increases without tempering them so much that unemployment spikes and the economy falls into a recession.

Fed officials have been struggling to figure out what is happening with the economy, as overall growth holds up but the job market slows.

“While a softening labor market suggests a weakening of economic activity, other economic measures suggest ongoing strength,” Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, said in a recent essay.

Friday’s report offered signs that the economy is pulling back — but not crashing. Consumer spending, which makes up a big part of overall economic activity, grew more slowly in August, the data showed. And personal incomes picked up less than expected.

In fact, some economists speculated that Fed officials might contemplate another large rate cut in November, given the muted inflation data and evidence that consumer spending is weakening.

“The next few months of employment readings, though, will be the key determinant in the pace,” Kathy Bostjancic, chief economist at Nationwide, wrote in a note about Friday’s report.

While Fed officials usually cut in quarter-point increments, and the central bank’s economic forecasts suggest that they will return to that pace in the months ahead, officials have been clear that bigger reductions are possible.

Christopher Waller, a Fed governor, suggested during an interview on CNBC last week that he might be willing to cut rates more rapidly if inflation slows notably.

“If the data starts coming in soft and continues to come in soft,” Mr. Waller said, he would be willing “to be aggressive on rate cuts to get inflation closer to our target of 2 percent.”

Fed officials try to keep inflation slow but positive: They think that modest price increases act like grease on the gears of the economy, allowing workers to win wage gains without killing corporate profits. So while officials want to wrestle price increases back to their 2 percent goal, they don’t want them to fall permanently below that.

Friday’s inflation figures are just the latest sign that inflation is coming back to the central bank’s target.

They come after this month’s Consumer Price Index report also showed inflation cooling. That measure, which provides a more timely reading on inflation using a different methodology, is now down to 2.5 percent from a peak of 9.1 percent in 2022. The Personal Consumption Expenditures measure peaked at a more muted 7.1 percent.

The Biden administration, for its part, has embraced the progress on inflation. For years, rapid price increases have dogged the White House, undermining consumer confidence.

Now that picture is shifting just in time for the presidential election in November.

“Our work isn’t done, especially on costs, but we’re moving in the right direction, and with some nice momentum,” Jared Bernstein, chair of the White House’s Council of Economic Advisers, said in an emailed statement.

For both the White House and the Fed, the next big point of focus will be the employment report for September, which is set for release next week.

Hiring has been cooling and unemployment has crept higher in recent months. Officials will watch closely as they try to assess whether the job market is returning to normal after a hot streak — or whether it is slowing in more worrying way.