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U.S. core inflation tops forecasts for a second straight month

The latest data on underlying U.S. inflation, excluding food and energy costs, revealed a second consecutive month of higher-than-expected figures in February. Prices surged for used cars, air travel, and clothing, reinforcing the Federal Reserve's cautious stance on cutting interest rates.

The core consumer price index (CPI), a key indicator of underlying inflation, rose by 0.4% from January, marking a 3.8% increase from the same period last year, according to government data released on Tuesday. Economists consider the core CPI as a more reliable measure of inflation trends than the overall CPI, which includes food and energy costs. The overall CPI climbed 0.4% from January and 3.2% from a year ago, primarily driven by rising gasoline prices.

Despite a robust reading in January, the latest report adds to the growing evidence that inflation is proving to be persistent, prompting central bankers to exercise caution in easing policy prematurely. Federal Reserve Chair Jerome Powell indicated last week that they are nearing the confidence level needed to consider rate cuts, but some officials are advocating for a more extensive pullback in prices before taking such measures.

Over the past three months, core CPI has increased at an annualized rate of 4.2%, the highest since June. Kathy Jones, Chief Fixed-Income Strategist at Charles Schwab, remarked, “This will probably be seen as a reason to keep policy on hold a while longer… the Fed would like to see [inflation] continue to move lower before easing rates.”

Market reactions were mixed, with traders initially focusing on details suggesting pockets of relief in inflation. However, attention quickly turned to the robust headline figures. As of 8:56 a.m. in New York, stock futures pared gains, and Treasury yields slightly increased.

Shelter and gasoline prices accounted for over 60% of the overall monthly increase, according to the Bureau of Labor Statistics (BLS). Prices also rose for used cars, apparel, motor-vehicle insurance, and airfares, posting the most significant monthly advance since May 2022.

Shelter prices, the largest category within services, increased by 0.4%, slowing down from the substantial jump in January. Owners’ equivalent rent, a subset of the shelter category and the largest individual component of the CPI, followed a similar pattern. Excluding housing and energy, services prices advanced 0.5% from January, down from 0.8% in the prior month, according to Bloomberg calculations.

While policymakers emphasize the importance of services prices when assessing the nation's inflation trajectory, the metric is based on a separate index from the personal consumption expenditures price index (PCE). The PCE, which places less weight on shelter than the CPI, is closer to the Fed's 2% target. February PCE figures are due later this month.

Contrary to the declining prices of goods over the past year, core goods prices, excluding food and energy commodities, rose for the first time since May. Policymakers, taking into account the robust labor market, have been hesitant to cut interest rates. A separate report released on Tuesday indicated that real earnings continued to rise on an annual basis, extending a streak where wage growth has modestly outpaced inflation.

Recent data also showed healthy hiring in February, despite the unemployment rate reaching a two-year high. As the last major inflation report before the upcoming Fed meeting next week, economists will closely analyze these figures for clues on the central bank's potential decisions regarding interest rates.