U.S. Inflation Cooled in February as Fed Confronts Bank Failures

Monthly data showed price pressures persisted in many corners of the economy. Core prices increased by a seasonally adjusted 0.5% in February, the largest monthly gain in five months. Shelter costs rose 0.8% over the month, matching the largest monthly gain since the 1980s.

Economists said Tuesday’s consumer-price index report underscored the urgency of the Fed’s inflation fight. Several thought it made officials more likely to raise rates next week by a quarter percentage point as long as the banking sector didn’t appear to come under additional stress ahead of its rate decision.

Prices for airfare and lodging also rose in February. Gasoline and food prices both increased last month, but at a slower pace than in January. Consumers paid less last month to heat their homes, and prices for medical services and used cars also fell.

Elevated inflation, combined with a strong labor market and solid consumer spending, appeared to put the Fed in a position to consider a larger interest rate increase at its March 21-22 meeting. But the collapse of Silicon Valley Bank and other financial institutions could lead the central bank to move more cautiously to assess the state of the financial system.

Investors in interest-rate futures markets on Tuesday placed a roughly 85% probability of a quarter-point increase at next week’s meeting, compared with a 15% chance of no increase, according to CME Group.

“The Fed still has more work to do” to bring inflation back to near its 2% target, said

Michael Gapen,

chief U.S. economist for Bank of America. “If the Fed is successful at corralling the recent market volatility and ringfencing the traditional banking sector, then it should be able to continue its gradual pace of rate hikes until monetary policy is sufficiently restrictive.”

Other economists said February consumer inflation figures were more likely to extend the Fed’s rate increase cycle later into the summer, with officials foregoing an increase next week.

“We think Fed officials will be reluctant to take the risk that monetary policy actions could work at cross-purposes with financial stability policy by worsening banks’ balance sheet problems and undermining confidence,” said

Jan Hatzius,

chief economist at Goldman Sachs. 

The bank expects the Fed to raise interest rates to around 5.4% this year, resuming rate increases after holding steady next week.

Fed officials slowed their pace of rate increases last month when they increased their benchmark rate by a quarter-percentage-point to a range between 4.5% and 4.75%. Sharply higher interest rates exacerbated problematic risk-taking decisions at the $110 billion Signature Bank and $209 billion Silicon Valley Bank, which were taken over by government regulators.

The coming March meeting could feature an intense debate over the benefits of holding rates unchanged to provide more time to see if the banking crisis eases versus continuing to raise rates to avoid creating new confusion over the central bank’s approach to controlling inflation.

Hot core inflation—prices rose 5.2% over the last three months at an annualized rate—has run well above economists’ expectations and further highlights the tension between the Fed’s financial-stability and price-stability goals. That could force markets “to reconsider what we see as an ill-founded view that the SVB crisis means the Fed is likely done raising rates,” said

Krishna Guha,

vice chairman of Evercore ISI.

Before the bank failures, the broader economy showed surprising strength to start the year. Spending at retailers and restaurants rose in January at the fastest monthly rate in nearly two years, and employers added more than 800,000 jobs during the first two months of the year.

At First Watch, a chain of more than 400 breakfast and lunch cafes, there has been little sign of a consumer pullback. While labor and related costs rose by 11.4% in 2022, the company raised menu prices by an average of 7.8% during the year, after being able to keep prices flat during 2021. Annual supplier contracts have helped keep the chain’s food costs predictable, while same-restaurant sales rose 14.5% compared with 2021. 

To capitalize on eager customers, the company is working to keep wait times low during peak periods such as weekend mornings. It is experimenting with different kitchen configurations and specialized roles such as dedicated beverage runners to free up servers. 

“We have unfulfilled demand that’s right at our front door,” First Watch Chief Executive Chris Tomasso said. “We’re investing in improvement and processes and equipment and things such as that to capture that demand.”

Still, some signs of cooling have emerged. Economists estimate that retail spending declined in February. The Commerce Department will release new consumer data on Wednesday.

Wage growth moderated last month, suggesting that tight labor markets aren’t leading to rapid increases in workers’ paychecks. And job openings, while still well exceeding the number of unemployed seeking work, fell in January, the Labor Department said. Private-sector job postings estimates show continued cooling demand for labor.

While consumer inflation is down from its recent peak last June, it is still well elevated from a prepandemic rate of just over 2%. High prices have caused some consumers to pull back and seek cheaper alternatives.

Ruby Koch-Fienberg and Ben Surface, of Dover, N.Y., shopped around for a contractor who would replace a malfunctioning wood-burning stove and demolish its damaged chimney. They were told that there was little chance the work could be completed this winter, given the backlogs of work, and the job could cost thousands of dollars. 

They are now contemplating doing the chimney demolition themselves.

“We could save up to $8,000 and have a really fun weekend,” Ms. Koch-Fienberg said.

Write to Gabriel T. Rubin at gabriel.rubin@wsj.com and Nick Timiraos at Nick.Timiraos@wsj.com

Corrections & Amplifications
Ruby Koch-Fienberg lives in Dover, N.Y. An earlier version of this article and a caption misspelled her last name as Koch-Feinberg. (Corrected on March 13)