Lower-than-expected inflation keeps the Fed on track to cut interest rates in October

It would have taken a surprise spike in inflation in September to deter the Fed from cutting interest rates in October, but that didn’t happen.

The Consumer Price Index rose 3% over the year in September, the Bureau of Labor Statistics said Friday. While this was the highest annual inflation rate since January, it was below forecasters’ expectations of a 3.1% rise.

Moreover, for the Fed, “core” inflation, which excludes volatile food and energy prices, rose 3%, down from 3.1% in August and also below expectations. Fed policymakers watch “core” inflation measures closely because they can be better indicators of the path of prices. Food and energy prices can rise and fall dramatically for reasons unrelated to broad inflation trends.

The report reinforced expectations that the Federal Reserve will cut its benchmark interest rate next week when the Fed’s policy committee is scheduled to meet. Fed officials cut the federal funds rate by a quarter of a percentage point in September to boost the faltering labor market. The Federal Reserve has kept interest rates high to combat inflation, but concerns about prices have given way to concerns about slowing hiring in recent months.

Even before Friday’s report, the Fed was widely expected to go ahead with lowering interest rates. Fed officials had planned to cut interest rates twice at their remaining two meetings this year, as noted in their quarterly monetary policy forecasts last month.

Financial markets are pricing in near certainty that the Fed will cut the federal funds rate to a range of 3.5% to 3.75% by the end of the year, half a percentage point below its current level, according to CME Group’s FedWatch tool, which forecasts interest rate movements based on federal funds futures trading data.

“There was little in today’s benign CPI report to spook the Fed and we continue to expect more easing at next week’s Fed meeting,” Lindsay Rosner, head of multi-sector fixed income investing at Goldman Sachs Asset Management, wrote in a commentary. “A rate cut in December also remains likely, as the Fed’s current data drought does not provide sufficient reason to deviate from the path outlined in the dot plot.”