US inflation rose sharply, market eyes 0.5% interest rate hike next month

US consumer prices rose solidly in January, leading to the biggest annual increase in inflation in 40 years, which could fuel financial markets speculation for a 50 basis points interest rate hike from the Federal Reserve next month.

The consumer price index gained 0.6% last month after increasing 0.6% in December, the Labor Department said on Thursday. In the 12 months through January, the CPI jumped 7.5%, the biggest year-on-year increase since February 1982.

That followed a 7.0% advance in December and marked the fourth straight month of annual increases in excess of 6%. Economists polled by Reuters had forecast the CPI rising 0.5% and accelerating 7.3% on a year-on-year basis.

Effective with the January report, the CPI was re-weighted based on consumer expenditure data from 2019-2020.

The economy is grappling with high inflation, caused by a shift in spending to goods from services during the Covid-19 pandemic. Trillions of dollars in pandemic relief fired up spending, which ran against capacity constraints as the coronavirus sidelined workers needed to produce and move goods to consumers.

Soaring inflation has reduced purchasing power for households and eroded President Joe Biden's popularity. This is despite the economy growing at its strongest rate in 37 years in 2021 and the labor market rapidly churning out jobs.

The Fed is expected to start raising rates in March, to rein in inflation, which has overshot the US central bank's 2% target. Financial markets are predicting a 25% chance of a 50 basis points increase, according to CME's FedWatch tool.

Market predictions are partly driven by the fact that price pressures are broadening, with several measures of wage inflation increasing strongly in recent months.

Economists, however, believe it is unlikely that the Fed would move so aggressively. They expect the central bank to raise rates by 25 basis points at least seven times this year.

"The Fed does not want to create undue volatility in its first hike, which only makes further increases more difficult," said Scott Ruesterholz, a Portfolio Manager at Insight Investment in New York. "Rather, the Fed would be more likely to guide to an accelerated pace of hikes at consecutive meetings to crack down on inflation."

Strong underlying inflation 

Excluding the volatile food and energy components, the CPI increased 0.6% last month after rising 0.6% in December. In the

12 months through January, the so-called core CPI jumped 6.0%. That was the largest year-on-year gain since August 1982 and followed a 5.5% advance in December.

Rising rentals and shortages of goods like motor vehicles are fueling the core CPI. Monthly inflation could slow in the coming months amid an easing in supply bottlenecks as coronavirus infections driven by the Omicron variant subside.

Government data this week showed goods imports increased to a record high in December as ships offloaded their cargo after months of delays because of labor shortages at ports. Wholesale motor vehicle inventories increased by the most in 10 years in December. read more

Still, inflation will remain high for a while, in part reflecting the delayed impact of rising wages. Employers are boosting compensation as they compete for scarce workers. There were 10.9 million job openings at the end of December.

"The factors that have driven inflation higher in 2021

are only expected to dissipate gradually and are likely to keep pushing inflation higher through the first half of 2022," said Kevin Cummins, chief US economist at NatWest Markets in Stamford, Connecticut.

"We expect that there will be a shift from goods inflation, particularly motor vehicle and commodities prices to more persistent services inflation, such as wages and heavily-weighted rents."

A separate report from the Labor Department on Thursday showed initial claims for state unemployment benefits fell16,000 to a seasonally adjusted 223,000 for the week ended 5 February. Economists had forecast 230,000 applications for the latest week. Claims increased from the beginning of January through the middle of the month as Omicron raged across the country.

They have dropped from a record high of 6.149 million in early April of 2020.