The November CPI report marked the second successive undershoot in inflation and there is mounting evidence that it will continue to fall sharply in 2023. (See Chart 1.) Core goods prices are coming under broad-based downward pressure, as easing supply shortages, the collapse in global shipping costs and the stronger dollar feed through. Services inflation is so far proving stickier, but a variety of alternative measures suggest that the single largest component, CPI rent inflation, will soon slow sharply. A further gradual easing in labour market conditions should also help. Although the economy appears to have held up in the fourth quarter, most leading indicators support our view that a recession is on the way, which will help to reduce inflationary pressures further. The upshot is that, despite the Fed’s continued hawkishness, we still expect interest rates to be falling again by late 2023. The past few weeks have seen markets largely come round to that view.
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