Dive Brief:

• Core inflation excluding food and energy, a gauge of underlying price pressure, rose 5.6% last month on an annualized basis compared with 5.5% in February, fueling expectations that the Federal Reserve will raise the main interest rate by a quarter percentage point in early May. The inflation measure increased 0.4% in March, a slight decline from 0.5% the previous month.
• The Consumer Price Index including food and energy, after rising 6% on an annual basis in February, slowed to 5% last month in the smallest 12-month gain since May 2021, the Labor Department said Wednesday. Yet much of the pullback stemmed from a 6.4% decline in energy prices compared with March 2022, when prices for oil, gas and other fuels surged following Russia’s invasion of Ukraine.
• “Core inflation remains stickier and more persistent than the Fed would like,” Morning Consult Chief Economist John Leer said in an email. “Combined with the strength of the March jobs report, there’s a growing case for the Fed to raise rates yet again at its next meeting” on May 2-3.

Dive Insight:

The Fed during the past year has raised the main interest rate more aggressively than at any time since the early 1980s but has yet to achieve a steady decline in core inflation toward its 2% target.

Price pressures persist as the U.S. job market, while cooling somewhat, remains unusually hot. Unemployment fell to 3.5% last month as employers hired 236,000 workers, the smallest increase in two years but still strong by historical standards.

“There are a number of signs that the labor market is starting to cool, but it remains extremely tight and is likely to come back into balance only gradually,” San Francisco Fed President Mary Daly said Wednesday.

Consumer spending and economic growth also “continue to outperform expectations” even though the central bank since March 2022 has raised the federal funds rate from near zero to a range between 4.75% and 5%, Daly said.

“The strength of the economy and the elevated readings on inflation suggest that there is more work to do,” Daly said. Policymakers “remain resolute and committed to bringing inflation down to our 2% goal.”

Investors on Wednesday set 70% odds that the Fed next month will hike the main interest rate by 0.25 percentage point, according to the CME FedWatch Tool. On April 5, before recent reports on inflation and the labor market, investors saw just 43% odds of a quarter-point increase and a 57% probability of no change, according to CME, which calculates expectations based on trading in interest-rate futures markets.

A credit tightening following failures by U.S. banks last month may reinforce Fed efforts to slow the economy and curb inflation, Daly said, echoing Fed Chair Jerome Powell and other central bank officials.

“Credit standards have risen over the past year and are expected to increase further in coming quarters,” she said. “Recent data on lending activity already point to declines in lending volumes in several sectors.”

The lending capacity of U.S. banks may fall 1% in 2023 as investors, responding to turmoil among midsize banks last month, pull back from the sector, the International Monetary Fund said Tuesday.

“Because regional and smaller banks in the United States account for more than one-third of total bank lending, a retrenchment from credit provision could have a material impact on economic growth and financial stability,” reducing gross domestic product by about 0.44 percentage point, the IMF said.

“This may allow for some recalibration of monetary policy as central banks have recently indicated,” according to the IMF.

At the most recent meeting of Fed policymakers on March 21-22, “many participants noted that the likely effects of recent banking sector developments on economic activity and inflation had led them to lower their assessments of the federal funds rate target range that would be sufficiently restrictive,” according to minutes of the gathering released Wednesday.

Fed officials forecast that the Federal Open Market Committee will raise the benchmark interest rate to 5.1% by the end of the year, according to a median projection released on March 22.