US CPI and the Fed: the door is ever so slightly ajar…but the Fed won’t walk through in March

Stephen Miller

The Federal Reserve (Fed) faces a somewhat different decision than the Reserve Bank of Australia (RBA).

In the absence of the sharp rise in oil prices, there would be an argument that the subdued February payrolls report released last Friday and a “benign enough” February consumer price index (CPI) report released overnight leaves the door ever so slightly ajar for the Fed to cut the policy rate when it meets next week.

The February core inflation measure at 2.5 per cent was the lowest since the depths of COVID back in March 2021 and comes despite the inflationary effects of tariffs. The US trimmed-mean measures came in around 2.7 per cent, the lowest since April 2021. By contrast the latest trimmed-mean inflation rate measure for Australia is at 3.4 per cent (12 months to January).

So on those measures, even with the price pressures arising from tariffs, the US better performed on inflation than Australia.

It is true that measures of the inflation “pulse” (3-month annualised measures) are less benign with core and trimmed-mean measures running at 3.0 per cent and 2.9 per cent respectively.

Also complicating the picture a little is that the Fed’s favoured core private consumption expenditures (PCE) measure is “sticky” at 3.0 per cent (12 months to December 2025), unchanged from where it was a year ago and still well north of the Fed’s target 2 per cent. The January figure is released on Friday. Consensus expectations imply little improvement and perhaps even a slight deterioration.

Federal Reserve Chair designate, Kevin Warsh, conjectures that disinflation in the US (of which there are glimpses in CPI-based measures) will follow from tremendous (largely AI motivated) investment. In Warsh’s view that investment has wrought a productivity dividend that (other things equal) has raised the US economy’s “speed limit”. In other words, the US economy can grow at faster rate before igniting inflationary pressures.

That is a credible –  if eminently debatable –  position.

That is what leaves the door ever so slightly ajar for policy interest rate reductions in the US.

Another question is oil prices. Do they have the potential to unanchor inflation expectations which were already under assault from tariff impositions? Are they inflationary? Or could they ultimately be disinflationary given the activity diminishing effects of higher oil prices.

During the 1990s and into the early 2000s oil prices had a stronger ultimate disinflation impact because there were a number of structural forces suppressing inflation.

It may be less true in 2026.

The globalisation of labour supply (after the fall of the Berlin Wall and the “export” of labour from large emerging market economies such as China and India) is abating; globalisation of goods markets is in retreat as governments everywhere introduce protectionist measures; domestic regulation of goods and labour markets is increasing in scope leading to loss of flexibility in markets and attendant upward price pressures or “sticky” inflation”; and baby boomer workforce participation is declining (limiting labour supply and lifting wages).

But what the US has going for it is that the surge in productivity is a structural disinflationary force that is not visible elsewhere, including in Australia. US productivity growth has averaged 1.6 per cent per annum since the end of 2021. The equivalent Australian figure is -1 per cent. To put it more starkly, US productivity has grown by 6.4 per cent in that time, Australia’s productivity has fallen by 4 per cent.

That arguably puts the Fed in a better position than the RBA to “look through” any inflation impact from oil prices.

For what it is worth, in the unlikely event of a sharp decline in annual core PCE in January, I suspect that the Fed will eschew a policy rate reduction next week. The Warsh “productivity dividend” thesis is probably not yet sufficiently established to offset the current “stickiness” in core PCE inflation and there is the lingering potential for the surge in oil prices to un-anchor inflation expectations.

But if the incoming Fed Chair’s thesis is borne out, the policy rate may yet be lowered later in the year.