Inflation to fall below 2% target next year, economist predicts

It won’t be long until the Federal Reserve can declare “mission accomplished” in its battle against inflation.

According to Morningstar senior economist Preston Caldwell, the core Personal Consumption Expenditures (PCE) index—the Fed’s preferred measure of inflation—will average 2.4% this year before dropping to 1.8% over 2025.

That’s below the central bank’s long-held, albeit controversial, 2% target.

Caldwell’s inflation optimism stems from a combination of supply chain improvements, weaker home-price growth, and a slowing economy.

“When peak inflation was raging in 2022, many economists thought that it would take a recession (perhaps a severe one) to bring inflation back to the Fed’s 2% target,” Caldwell wrote.

“But the U.S. economy has defied those pessimistic predictions,” he added. “In terms of the exact timing, we expect core PCE to hit 2% year over year sometime in the first quarter of 2025.”

Caldwell’s forecast might not be so far-fetched after all.

In May, the core PCE index posted its smallest monthly increase in three and a half years. On a year-over-year basis, the index fell to 2.6%, the lowest since March 2021.

Other inflation metrics, such as the Consumer Price Index (CPI), are also hovering at multiyear lows. June’s CPI print was 3% year over year, the lowest since 2021.

Although Caldwell didn’t predict how the Fed would respond to falling inflation, there’s a good chance policymakers will use it as justification to follow through on rate cuts.

Powell shifts focus

One of the most telling signs that the Fed is eyeing a September rate cut is the gradual shift in tone from its chair, Jerome Powell.

During his congressional testimony on July 10, Powell reminded lawmakers of the Fed’s dual mandate of price stability and full employment. According to Powell, the Fed’s focus isn’t just taming inflation.

“We need to be mindful of where the labor market is,” he stated.

Powell also admitted that high inflation “isn’t the only risk we face,” referring once again to employment, which has lost its stride over the past year, with unemployment rising from 3.4% to the current rate of 4.1%.

Economists warn that another rise in the jobless rate could trigger the dreaded Sahm Rule, which marks the beginning of a recession.

The Sahm Rule sets off a recession when the unemployment rate’s three-month average rises by at least half a percentage point from its low during the previous 12 months.

Economists predict that could happen as soon as August.

Other indicators also suggest that joblessness is on the rise. According to the Department of Labor, jobless claims rose by 20,000 to 243,000 in the week ending July 13. That matches the highest level since August 2023.

Perhaps more concerning is the fact that continuing claims—or the number of workers receiving recurring unemployment benefits—also rose by 20,000 to 1.87 million in the week of July 6, the highest in nearly three years.