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Inflation slowed to 6.5% in December from a year ago

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Inflation subsided in December, reflecting the smallest annual increase since October 2021, the Labor Department reported Thursday.

The Consumer Price Index rose at an annual rate of 6.5%, in line with economists' expectations.

Core prices, which exclude energy and food, rose 5.7% from the year before. 

On a monthly basis, prices fell by 0.1% between November and December, as lower costs for gasoline, energy services and other goods offset increases in the price of food, shelter and gas for heating and cooking.

"Inflation is heading in the right direction but is still far too high for the Fed to take much comfort from this print," Brian Coulton, chief economist at Fitch Ratings, said in an email. 

Cheaper goods, pricier services

Price increases for goods, like cars, furniture and clothing have cooled as the supply-chain snarls that drove inflation last year have mostly unraveled. The cost of goods has now dropped for three straight months. However, inflation in services — such as travel and entertainment — is now a closely watched metric, as some economists believe services inflation will be harder to tame.

"Services inflation is 7%, and this is not just a story about rental inflation — which keeps jumping in leaps and bounds," Coulton said. Federal Reserve Chair Jerome Powell "has flagged services excluding rents as a key aggregate to watch and this is not really showing any signs of slowing down."

The Federal Reserve has been laser-focused on crushing inflation, hiking its key interest rate seven times last year to a range of 4.25% to 4.5%. Raising interest rates slows inflation by making it more expensive to buy things, and have helped drive price increases down from a summer peak to their current level.

The 6.5% annual rate of inflation, while the lowest in over a year, is still roughly triple the 2% level the Fed wants to see. Wall Street expects the Fed to increase rates several more times this year, although in smaller increments than last year's jumbo-sized hikes.

"Coming in line with expectations, the ongoing slowing in inflation provides the Federal Reserve room and reason to pare the size of its policy rate increases," Nationwide Chief Economist Kathy Bostjancic said in a note. "While it shows that the monetary policy tightening so far has been successful, with the annual rate of headline and core readings well above the 2% target level the Fed is not done tightening."

Falling expectations

Another positive sign for the Fed's efforts to quell inflation is that Americans overall expect price increases to decline over the next few years. That is important because so-called "inflation expectations" can be self-fulfilling: If people expect prices to keep rising sharply, they will typically take steps, like demanding higher pay, that can perpetuate high inflation.

On Monday, the Federal Reserve Bank of New York said that consumers now anticipate inflation of 5% over the next year. That's the lowest such expectation in nearly 18 months. Over the next five years, consumers expect inflation to average 2.4%, only barely above the Fed's 2% target.

With reporting by the Associated Press.

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