Hot US inflation report tests market optimism on rate cuts

Consumer Price Index rose higher than expected in December at 3.4 per cent

Major indexes on Wall Street soared last month after the Federal Reserve signalled several interest rate cuts were coming this year. AFP

Fuelled by higher housing costs, US inflation rose higher than expected in December, testing markets' optimism as they anticipate the Federal Reserve will cut interest rates this year

The Consumer Price Index rose 0.3 per cent last month after a 0.1 per cent gain in November, the Labour Department reported on Tuesday.

Inflation rose 3.4 per cent on an annual basis, up from 3.1 per cent in November. Economists polled by FactSet forecast inflation would rise 3.2 per cent year-on-year.

Core CPI – which excludes food and energy – had the same monthly increase as in November, of 0.3 per cent.

On an annual basis, core CPI rose 3.9 per cent, slightly higher than FactSet's 3.8 per cent projection but lower than November's 4 per cent reading.

Shelter contributed to half of the monthly all-items increase, the Labour Department reported.

Thursday's report – the first US inflation reading this year – comes as traders forecast when the Federal Reserve will cut interest rates this year, and by how much.

Ahead of the report, data from the CME Group showed most forecast the Fed to announce its first rate cut of this policy cycle in March.

Most expected interest rates to fall somewhere between 3.75 per cent and 4.25 per cent by the end of this year.

“I think March is probably too early … for a rate decline because I think we need to see some more evidence,” Federal Reserve Bank of Cleveland President Loretta Mester told Bloomberg TV.

Ms Mester, who will vote on the Fed's policy decisions this year, said that Thursday's report “shows there's more work to do” to bring inflation under control.

The Fed has raised interest rates 11 times in a row in its tightening cycle to the current rate of 5.4 per cent, hoping higher borrowing costs would cool demand.

Wall Street's major indexes soared when the Fed indicated at the end of last year that it would move from raising interest rates to cutting them.

But that momentum failed to carry into this year.

The US stock market was little changed when trading closed on Thursday.

The Dow Jones Industrial Average gained 0.04 per cent while the Nasdaq Composite rose by a near-zero percentage point. The S&P 500 also changed little, sliding by 0.07 per cent.

The US central bank's turnaround in December came as inflation declined significantly without a sharp rise in unemployment.

Markets' optimism on rate cuts stands in contrast to the Fed's own projections, however. The central bank's most recent estimations forecast three rate cuts this year.

And minutes released from a December 12-13 meeting showed officials are uncertain on when they might begin cutting rates.

The minutes also showed the Fed still believes rates will be elevated “for some time” until the central bank sees clear evidence it is moving down towards its long-term 2 per cent goal.