Inflation picked up in the first month of the year, defying optimism from investors and officials over a steady move lower seen in recent readings.
The Consumer Price Index (CPI) for January showed a 0.5% increase in prices over the past month, an acceleration from the prior reading, government data showed Tuesday. On an annual basis, CPI rose 6.4%, continuing a steady march down from a 9.1% peak last June.
Economists had expected prices to climb 6.2% over the year and jump 0.5% month-over-month, per consensus estimates from Bloomberg. New seasonal adjustments released by the BLS on Friday also switched December's initial reading of a 0.1% monthly drop in headline inflation to an increase of 0.1% in the year's final month.
Core CPI, which strips out the volatile food and energy components of the report, climbed 5.6% year-over-year, more than expected, and 0.4% over the prior month. Forecasts called for a 5.5% annual increase and 0.4% monthly rise in the core CPI reading.
U.S. stocks slid following the release, while Treasury yields declined, as investors assessed the implications of Tuesday's release on Federal Reserve policy,
The headline figure for January was the smallest 12-month increase since the period ended October 2021, while the core annual reading was the smallest since December 2021. Even as the inflation picture has improved since the peak of the current cycle last year, rising costs for essential items remain a burden for U.S. consumers.
Policymakers monitor "core" inflation more closely due to its nuanced look at key inputs like housing, while the headline CPI figure has moved largely in tandem with volatile energy prices last year.
Housing prices continued to be the dominant factor in the CPI report by far, accounting for nearly half of the monthly jump in inflation, the Bureau of Labor Statistics said.
The shelter category of CPI — which accounts for 30% of overall CPI and 40% of the core reading — increased 0.7% over the month and 7.9% over the last year.
For Fed Chair Jerome Powell, shelter inflation — a "stickier" component of CPI that has remained stubbornly high — is a key component of evaluating the path forward for interest rates. In a sit-down interview last week in Washington, D.C., Powell said he expects housing inflation to fall in the middle of the year.
"There has been an expectation that [inflation] will go away quickly and painlessly; I don’t think it’s guaranteed that’s the base case," Powell said last Monday at the Economic Club of D.C., even as he acknowledged the presence of "disinflation" in the economy. "It will take some time."
“The strength of core inflation suggests that the Fed has a lot more work to do to bring inflation back to 2%," Maria Vassalou, co-chief investment officer of Multi-Asset Solutions at Goldman Sachs Asset Management said in a note. "If retail sales also show strength tomorrow, the Fed may have to increase their funds rate target to 5.5% in order to tame inflation.”
Food prices increased 0.5% in January, up from December's 0.3% increase, while the cost of food at home rose 0.4%. Egg prices, which have risen 70% over the past year and 8.5% over the past month, were a significant contributor.
An increase in energy prices was also a big contributor, with the energy index climbing 2% over the month.
Some improvements in the inflation picture were seen in the report. Prices for used cars and trucks, medical care, and airline fares decreased over the month.
Investors have recently recalibrated expectations over how quickly inflation is falling and how high the Federal Reserve will raise rates in order to stabilize prices.
Last week, the CME Group's FedWatch Tool, which measures market expectations for the federal funds rate, showed the range with the highest probability at the end of the year was 4.50-4.75%, or the current rate after the Fed's 0.25% increase earlier this month.
The new modal estimate now sees rates at 4.75-5.00% at the end of this year.
"[Inflation is] down substantially from the peak, and we'll probably see inflation continue to moderate as the year goes on. But even by year-end, optimistically, inflation is still going to be up 3%, maybe 3.5% from a year and a half ago," Cumberland Advisors chief U.S. economist David W. Berson told Yahoo Finance Live Monday.
"My guess is the Fed will not ease this year — it may not tighten much more, we might see fed funds at the peak go a little above 5% — but that's very different from an expectation that by year-end the Fed will ease."
Alexandra Semenova is a reporter for Yahoo Finance. Follow her on Twitter @alexandraandnyc