Editor's note: After raising rates in September, the Fed has been handed another inflation report that offers little reassurance. The market had expected the monthly core CPI gain to fall back to 0.2%, but it instead held at 0.3% for a second consecutive month. At the same time, the cooling in housing inflation has stalled, and non-housing services prices have also strengthened.

For the Fed, higher oil prices alone may not require an immediate rate hike, but if energy prices remain elevated and core inflation refuses to cool, the room to wait and see will narrow. In his latest analysis, Gianluca Benigno argues that the September CPI strengthens the case for further rate hikes and makes the October meeting a possible window for action. The key going forward is whether the remaining data can provide enough evidence that underlying inflation is still falling.

The original text follows:

Core inflation exceeds expectations for a second straight time, cooling hopes dashed again

The most unsettling aspect of the September CPI for the Fed is that price growth excluding food and energy still has not slowed.

Core CPI rose 2.6% year-on-year that month, above the market expectation of 2.5% and August's 2.4%; on a seasonally adjusted basis, it rose 0.3% month-on-month, unchanged from August and above the market expectation of 0.2% for a second consecutive month.

Headline CPI rose 3.7% year-on-year and 0.6% month-on-month on a seasonally adjusted basis. Gasoline prices rose 9.1% month-on-month, contributing more than half of the monthly increase in headline CPI, indicating that energy remains the main force pushing overall prices higher.

But the simultaneous occurrence of higher energy prices and unchanged core inflation gives this report a policy implication that leans more toward tightening. Even if oil price volatility is temporarily excluded, the pace of increase in other consumer prices has not slowed to the extent the market had hoped.

Core CPI rose from 2.4% year-on-year to 2.6%, a reading that warrants cautious interpretation. According to Benigno's calculations, the unrounded year-on-year increase actually rose from about 2.45% to 2.56%, a gain of roughly 0.11 percentage points. The low base from the same period last year also amplified the change in the year-on-year reading.

Therefore, one cannot conclude that core inflation has suddenly accelerated sharply based solely on a 0.2 percentage point rise in the published figure. What truly matters for policy judgment is the monthly trend: the slowdown the market had hoped for did not materialize, and a 0.3% month-on-month increase in core CPI appeared once again. Although this alone is not enough to confirm a new inflation upcycle, it means the Fed still lacks evidence to comfortably pause rate hikes.

Strength in housing and services weakens the case for waiting further

Changes within core inflation deserve more attention than the headline number alone.

Previously, the gradual cooling of housing inflation was seen as an important force driving core inflation lower. But in September, that process stalled.

Housing prices rose 3.2% year-on-year, up from 3.0% in August, while the seasonally adjusted month-on-month gain rose from 0.3% to 0.4%, contributing about half of the month's core CPI increase. Among these, owners' equivalent rent — the estimated rental value of owner-occupied housing — rose 0.3% month-on-month, up from 0.2%; rent of primary residence held steady at 0.2%.

The year-on-year strengthening in housing was partly due to a low base effect, but the acceleration in the seasonally adjusted month-on-month reading indicates that recent price trends have indeed shifted. For the Fed, this means a component that was expected to continue pulling core inflation lower has temporarily failed to play its anticipated role.

Beyond housing, services prices also remained resilient.

Core services prices excluding housing, often referred to as "super core" services prices, rose 3.2% year-on-year, up from 3.1%, with the seasonally adjusted month-on-month gain holding at 0.3%. Transportation services rose 0.6% month-on-month, with airfares up 1.2%; hospital services and education services rose 0.7% and 0.6%, respectively.

Benigno believes that the strength in transportation services prices suggests higher energy costs may be starting to pass through to some services prices. However, healthcare, education, and housing each have different price drivers, and these gains cannot all be attributed to oil prices.

The policy difficulty lies in the fact that energy pressures have not yet subsided, and neither housing nor other services are providing sufficient cooling. If this combination persists, it will be harder for the Fed to rely on waiting to confirm that inflation will decline on its own.

The goods sector retained some relatively moderate signals. Core goods prices rose 0.7% year-on-year in September, unchanged from August; apparel rose 3.4% year-on-year, down from 3.6%. Although the seasonally adjusted month-on-month gain in core goods rose from 0.1% to 0.3%, there is not yet evidence of broad acceleration in year-on-year gains.

This means that a more accurate description at present is that core inflation stickiness has strengthened, rather than all areas having already entered a broad-based price increase.

Reasons for a October rate hike have strengthened, but subsequent data are still needed for confirmation

The Federal Reserve already raised rates by 25 basis points at its September meeting, lifting the target range for the federal funds rate to 3.75%–4.00%, with all 12 voting members supporting the decision. The policy statement also noted that economic activity is expanding solidly, domestic spending remains resilient, and inflation remains elevated.

Against this backdrop, the September CPI effectively tested one question: can underlying inflation continue to slow, providing a basis for the Federal Reserve to pause and observe the effects of earlier tightening?

This report did not provide the expected support.

Core CPI did not decline on a month-over-month basis, and housing and non-housing services strengthened somewhat, weakening the argument that "after the September rate hike, it is possible to continue waiting." However, one report cannot measure the full effects of the previous rate hike, and the transmission of monetary policy to demand and prices takes time.

Benigno's judgment leans more toward further tightening. According to his understanding of the Federal Reserve's reaction function (that is, how the central bank adjusts policy based on economic data), policymakers will simultaneously consider how long inflation has remained above target, the resilience of the economy and employment, and whether financial conditions are sufficient to restrain demand.

If the economy remains solid, the labor market does not weaken markedly, and core services inflation remains strong, the case for the Federal Reserve to raise rates further will strengthen. Conversely, if subsequent data show a clear cooling or financial conditions tighten significantly, there is still a basis for pausing to observe.

It is also necessary here to distinguish between indicators: the Federal Reserve measures its 2% inflation target using the PCE price index, while core CPI is an important reference and its gap from 2% cannot be mechanically converted into the number of rate hikes.

For the meeting on October 27–28, what needs to be watched next includes producer prices, inflation expectations, employment, and financial conditions. Among these, whether housing and non-housing services can slow again will affect the Federal Reserve's judgment on the persistence of price pressures.

The September CPI has not yet made a October rate hike a foregone conclusion, but it has raised the evidentiary threshold required for pausing rate hikes. With core inflation not cooling as expected, if the Federal Reserve chooses to continue waiting, it will need to find more convincing reasons from other data.

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