Crucially, core consumer inflation also moderated more than expected, rising by 0.3% m/m in October versus expectations for an increase of 0.5% m/m. Consequently, the annual rate of core inflation slowed to 6.3%, down from 6.6% in September, and against market expectations for a slight moderation to 6.5%. Core inflation (specifically shelter inflation) has become a critical focal point, because to get the overall rate of inflation back down to the target of 2%, shelter inflation will need to slow considerably. In October, shelter inflation rose further to 6.9% y/y, although the monthly rate of increase eased fractionally to 0.7% m/m (seasonally adjusted) down from 0.8% m/m in September.

Fortunately, it is still realistic to argue that the high base effect in energy and food inflation is likely to do the ‘heavy-lifting’ in getting US headline inflation considerably lower over the coming 12 months. However, getting the underlying (core) rate of US inflation down to around 2-2.5% is going to require more than simple base effects - including sustained high interest rates (and a likely economic recession) that significantly curtails the current excess demand in the labour market (excess demand in the housing market has already declined meaningfully).

Overall, the lower-than-expected monthly increase in both headline and core consumer inflation is very encouraging for financial markets, suggesting that the continued increase in US interest rates is slowly having the desired impact. This is the first time US inflation has surprised on the downside in recent months and it will encourage the US Federal Reserve (Fed) to slow the pace of rate hikes from 75 bps to 50 bps when the Federal Open Market Committee (FOMC) meets in December 2022. Nevertheless, it is going to be difficult for the Fed to achieve its inflation target within a reasonable timeframe without hiking US interest rates further and without pushing the US economy into recession. Stated differently, having a very high level of inflation that broadened into a wide range of categories (including shelter) at the start of the interest rate tightening cycle made it much less likely that the Fed could avoid pushing the US economy into a substantial downturn as it tries to control inflation. While base effects will be extremely helpful in getting US headline inflation lower in 2023, the core level of inflation will test the Fed’s commitment to achieving its inflation target of 2% – and will increasingly become the key area of policy focus and debate.