The Consumer Price Index dipped below 5% in April for the first time in nearly two years

Inflation has been among the greatest economic challenges for policymakers and a source of frustration for consumers over the past few years. Peak inflation is in the rearview mirror and continues to gradually fade from view, but sticky core inflation readings suggest that consumers will still be feeling the effects of higher prices for some time.

The consumer price index (CPI) rose by 0.4% in April, a result that was in line with expectations. That alone might still seem like a relatively high single-month uptick, and it would be weighed against the ultra-low inflation environment of the decade leading up to the pandemic. Still, it was enough to allow the trailing 12-month index reading to fall to 4.9% — its slowest pace in two years. It’s also half the 0.8% average monthly increase in the first half of 2022.

Food prices were flat for the second consecutive month, which is particularly good news for lower-income households that spend a much larger portion of their monthly income at the grocery store. Conversely, energy prices rose by 0.6%, but remain down over 5% in the past year, helped by a double-digit decline in prices at the pump.

A reduction in price pressures for food and energy is the good news. The challenge still lies in core inflation, which is less subject to volatile price swings and is proving to be sticky. The 0.4% rise in core CPI in April was relatively consistent with the monthly pace since December, although the underlying drivers continue to evolve.

As anticipated, shelter costs are showing signs of cooling; the 0.4% April increase was half of the February pace and the lowest single-month uptick in over a year. Various gauges of home prices rolled over last summer, but the effect is always subject to a lag before becoming apparent in the index. The combination of lower single-family home prices and more subdued rent increases are expected to continue to flow through to the CPI in the coming months.

The sharp uptick in core goods prices, led by a surge in used auto prices, was more concerning. Moreover, the increase in core services ex-housing of 0.4% showed no signs of easing, reflecting labor market conditions that remain quite tight by virtually any standard.

The continued upward pressure on service sector costs illustrates the “good news is bad news” nature of labor market strength. Demand for workers remains quite strong, as illustrated by the elevated level of job openings even with the exceptionally low unemployment rate. That competitive labor market has lifted wages sharply in recent years, a dynamic that has been particularly apparent in the service sector, where labor costs are the largest expense. Higher wages may have benefitted worker paychecks, but those increases have been largely passed along to customers in the form of higher prices. It’s felt by consumers as household budgets get squeezed, weighing on discretionary spending. It’s also readily apparent in the macro gauges of the economy that are the primary focus of Fed policymakers.

What does this report mean for the Fed? Probably very little. The Fed was already poised to stand pat at its next policy meeting, having already aggressively raised its benchmark interest rate by 500 basis points in just over a year. The full effect of those cumulative rate hikes hasn’t yet been felt but should continue to be absorbed in the coming months. The recent turmoil in the banking sector may not be the primary reason for their decision to pause, but tighter lending standards and reduced demand for credit represent a growing headwind for the economy.

Barring an upside surprise in prices, the consumer price index should continue to retreat over the next few months. A decline to below 4% when the June report is issued looks quite possible, if not likely. From there, the path to 2% could prove to be more challenging, particularly in the absence of a marked slowdown in the economy.

The bottom line? Progress is being made in the Fed’s fight against inflation, but it’s slower than anyone would prefer. Inflation should continue to ease in the coming months, but a return the central bank’s 2% target could take much longer. Even so, the fact that the CPI has now edged below 5% is another symbolic threshold breached on the path back toward a more normal inflation environment.