Core Inflation Slows to 3.2% in December: What's Next for Monetary Policy?

The core inflation rate, which excludes volatile food and energy prices, slowed to 3.2% in December, falling short of market expectations. This development has significant implications for monetary policy and the broader economy. Let's delve into the factors contributing to this slowdown and explore its potential impact on the coming months.



The slower-than-expected core inflation rate in December can be attributed to several factors. First, energy and food price declines have contributed to the moderation of headline inflation, which in turn affected core inflation. According to the OECD, overall inflation has moderated meaningfully in recent months, with energy and food prices falling significantly (OECD, 2024). Second, services inflation has proven to be particularly sticky and has abated only slowly. This is evident in the OECD's data, which shows that services price inflation has remained relatively high compared to other categories (OECD, 2024). Third, the easing of financial conditions, despite continued monetary policy tightening by central banks, has contributed to the slowdown in aggregate demand and, consequently, inflation pressures. This is highlighted in the IMF's report, which notes that financial conditions have eased notably in the United States and euro area in recent quarters (IMF, 2024). Lastly, investors' expectations for inflation have played a role in the moderation of core inflation. Market pricing shows that investors expect headline inflation to continue to decline quite rapidly in coming quarters, which may have contributed to the slowdown in core inflation (IMF, 2024).

The change in core inflation, which has declined more slowly than headline inflation, impacts the monetary policy outlook for the coming months by presenting a challenge to central banks in their efforts to bring inflation back to their 2% targets. This is because financial conditions, as proxied by an index that summarizes financing costs faced by firms and households in housing, credit, and equity markets, have eased notably in the United States and euro area in recent quarters. This easing has occurred despite continued monetary policy tightening by the Federal Reserve and ECB, in part reflecting investors' relatively benign outlook for price pressures—an assessment that has boosted market valuations. However, the recent easing may complicate the fight against inflation by preventing the slowdown in aggregate demand that may be needed to tamp down inflation pressures. Additionally, a prolonged period of extremely loose financial conditions combined with a monetary policy tightening cycle that started when inflation was already elevated may have dulled the transmission of monetary policy to financial conditions, further complicating the central banks' efforts to control inflation.

In conclusion, the slowdown in core inflation to 3.2% in December presents both challenges and opportunities for monetary policy. Central banks must navigate the delicate balance between maintaining inflation control and avoiding a hard landing for the economy. As the data continues to evolve, investors and policymakers alike will be closely monitoring the trajectory of core inflation and its implications for the broader economy.