Fed's preferred inflation gauge falls below 3% for first time since March 2021

The Fed's preferred inflation gauge has moved below 3% for the first time since March 2021, before the start of the central bank's rate-hiking campaign.

The Personal Consumption Expenditures (PCE) index grew 2.6% year over year in December, in line with last month's print. "Core" PCE, which excludes the volatile food and energy categories, grew 2.9%, down from 3.2% from the month prior and below the 3.0% economists surveyed by Bloomberg had expected.

Core PCE is the inflation measure mentioned most often by Fed Chair Jerome Powell.

Month over month, core PCE rose 0.2% in December, up from 0.1% in November. Importantly, annualized core PCE over the last three and six months is now below the Fed's 2% target.

"Core PCE inflation has been running at an annualized pace in line with the Fed’s 2% target for seven months now," Capital Economics deputy chief US economist Andrew Hunter said in a note to clients. "This reiterates the message that there isn’t really any 'last mile' of disinflation still to achieve and that, even with real economic growth still resilient, there is plenty of scope for the Fed to start cutting interest rates soon."

The inflation data could fuel expectations that the central bank will soon start cutting interest rates after two years of hikes. During the December Fed press conference, Powell told Yahoo Finance's Jennifer Schonberger that the Fed would want to be "reducing restriction on the economy" well before inflation hits 2%.

"Ultimately, the driver of rate cuts, in my view, is what happens to inflation," Goldman Sachs chief economist Jan Hatzius told Yahoo Finance Live on Jan. 17. "And the disinflationary trend cutting through the monthly ups and downs, that's still very much intact."

Entering Friday's print, markets had now priced in a roughly 50-50 chance of a rate cut in March, per the CME FedWatch Tool. The Federal Reserve's next decision on interest rates is slated for Wednesday, Jan. 31.

Read more: What the Fed rate-hike pause means for bank accounts, CDs, loans, and credit cards

December's PCE reading falls in line with the month's Consumer Price Index, another closely watched inflation measure, which also showed cooling core price increases. December's CPI report showed core inflation was 3.9%.

Importantly, both prints have combined with recent positive reads on the economy. On Thursday, fourth quarter economic growth came in higher than expected. A day prior, data from the S&P Flash PMI showed economic output hit its highest levels in seven months in January. This comes as consumer spending has remained resilient and the labor market has remained intact.

Bank of America chief US economist Michael Gapen captured the flavor of the current economic moment in a weekly commentary released on Friday morning.

"The economy continues to defy expectations," Gapen wrote. "Progress on inflation continues despite the resiliency of the activity data. ... Solid growth and falling inflation support our soft-landing view."

Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.

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