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August Saw a Decrease in the Inflation Measure Preferred by the Federal Reserve

Federal Reserve officials received more good news in their battle against rapid inflation on Friday, when a key inflation measure continued to slow, the latest evidence that a return to normal after the pandemic and higher interest rates are combining to wrestle rapid price increases back to a more normal pace.

The Personal Consumption Expenditures Index, which the central bank uses to define its 2 percent inflation goal, rose slightly more quickly last month as higher gas prices gave it a boost. It rose 3.5 percent in August from a year earlier, up from 3.4 percent in July.

But after removing food and fuel costs, both of which are volatile, a “core” inflation measure that Fed officials watch closely is starting to cool significantly. That measure increased by 3.9 percent from a year earlier, down from 4.3 percent in July. Compared with the previous month, it climbed by 0.1 percent, at a very slow pace.

It is the latest encouraging sign for Fed policymakers, who have been raising interest rates since March 2022 in an effort to slow the economy and cool price increases. While economic momentum has held up better than expected, a less optimistic housing market and a gradual return to normalcy in the car market have helped subdue key prices such as automobile and rents. Additionally, supply chain disruptions that led to shortages and significant price hikes in 2021 have gradually resolved, allowing costs for many goods to stop rising or even decrease slightly.

“I don’t think they are fully confident yet that core inflation has sustainably slowed; this is adding another building block on gaining that confidence,” said Omair Sharif, founder of the research firm Inflation Insights.

Given the progress, central bankers are now considering whether they need to raise interest rates further. They left them unchanged and in the range of 5.25 to 5.5 percent at their meeting this month, while forecasting that they might make one more rate increase this year. At the same time, given the strength of the economy, officials have indicated that they may need to keep interest rates at a high level for a longer period to ensure inflation returns to normal in a sustainable way.

“We’re taking advantage of the fact that we have moved quickly to move a little more carefully now,” Jerome H. Powell, the Fed’s chair, said during a news conference following the Fed’s meeting last week.

Mr. Sharif said he thinks the Fed could hold off on a rate move in November in light of the fresh inflation report, but an increase is still possible in December, as inflation may pick back up slightly this autumn.

“I don’t think this takes another rate hike off the table just yet; I don’t think they are fully confident yet, and I don’t think they should be,” he said.

Market pricing suggests that investors see roughly a one-third chance of a rate increase in December as of Friday morning. Longer-term bond yields have also increased in recent weeks, indicating that Wall Street is increasingly convinced that the Fed will keep its policy rate higher for longer. Stocks climbed following Friday’s report.

“This is certainly one to file under ‘very welcome news’: The stock market loves it, the Treasury market loves it, and I think that’s the right reaction,” said Ian Shepherdson, chief economist at Pantheon Macroeconomics. “They’re not going to declare victory on the back of this report” but “the emerging downward trend is pretty clear now.”

A key question now is whether inflation can fully fade — getting back to something close to the Fed’s 2 percent goal and staying there — without a larger economic slowdown.

So far, the economy has maintained surprising momentum. Retail sales figures and company earnings calls have indicated that American consumers are managing to keep spending despite higher borrowing costs, which have made it more expensive to make big purchases with borrowed money.

But Friday’s report also contained good news for the Fed in terms of consumption. Consumers continue to spend, but not as enthusiastically. The report showed that personal consumption expenditures rose 0.4 percent in August from the previous month, a slower pace than in July and below economists’ expectations.

Historically, it has been difficult for the Fed to reduce inflation without causing a significant economic downturn. Companies generally raise prices when they can, so it requires decreased demand to make them stop. Fed policy is a blunt instrument, making it challenging to calibrate precisely.

And risks still exist. The government is approaching a potential shutdown, which could negatively impact economic growth if it happens. Auto industry strikes could disrupt car and parts production if they continue, and elevated crude oil prices could contribute to inflation if they spill over and push up pump prices.

However, as price increases fade and the economy shows signs of steady settling, central bankers have expressed hope that they will be able to achieve a rare “soft landing” and cool price increases without stifling growth.

“We will get inflation back to our target, whatever that takes,” Austan Goolsbee, the president of the Federal Reserve Bank of Chicago, said during a speech this week. “But we also can’t lose sight of the fact that the Fed has the chance to achieve something quite rare in the history of central banks: to defeat inflation without tanking the economy.”

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