Nearly a year after the Federal Reserve launched the most aggressive rate hike cycle in its history, inflation has stubbornly refused to surrender, boosting the odds of a prolonged period of uncompromising monetary policy tightening.

Personal consumption expenditures excluding food and energy, known as "core" PCE and a key inflation metric for the Fed, increased 4.7% from January 2022 to January 2023, the U.S. Bureau of Economic Analysis reported Feb. 24. This was above economists' forecasts and the annual increase of 4.6% in December 2022.

Inflation remains well above the central bank's target of 2%, with few signs that prices will fall there anytime soon. Still, the Fed is highly unlikely to back off its push to bring inflation down to the target through higher rates, economists and other Fed watchers believe, and appears ready to continue to hike rates even as its pricing goals appear more difficult to achieve.

"I don't think there is any chance that the Fed backs away from its 2% target," said Kathy Jones, managing director and chief fixed-income strategist with the Schwab Center for Financial Research. "It would be damaging to their credibility and result in even higher inflation expectations."

No circumstances

The Fed's long-stated policy goal has been to get core PCE inflation back to 2%, a level it has not been at since March 2021. While inflation is moving in the wrong direction, sticky price increases and last week's hotter-than-expected reading have not compelled Fed officials to weaken that goal.

"There's no serious discussion about raising the long-run objective," said Joel Prakken, chief U.S. economist at S&P Global Market Intelligence. "No one at the Fed is seriously considering this."

Fed Chairman Jerome Powell has dismissed speculation that the Fed could consider raising its inflation goals to 3% or 4% as rising prices have failed to be tamed.

"We're not going to consider that," Powell said during a December 2022 press conference. "Under any circumstances."

The central bank has raised its benchmark federal funds rate by 450 basis points since March 2022 and appears poised to hike above 5% for the first time since 2007.

Tough path

After seemingly peaking in February 2022 at 5.4%, core PCE fell to 4.7% by July as it appeared the Fed's efforts to tighten policy would be effective in cooling prices. Core PCE then rose to 5.2% in September and has averaged 4.9% over the past five months.

Declines could also prove very difficult going forward.

"The path from 4% to 2% could be a lot tougher than the path from 5% to 4%, especially since services inflation is still so high," said Callie Cox, a U.S. investment analyst at eToro.

In the past, it has taken roughly a year to get core PCE down 2 percentage points, requiring a hawkish Fed and policy actions that have coincided with a recession, Cox said.

Economic consequences

While further monetary policy tightening to get core PCE down to 2% could trigger a recession, shifting away from the Fed's current goal may also prove economically disastrous.

"Moving the inflation goalpost when you're down by four touchdowns is not the optimal strategy," said Gregory Daco, chief economist with EY Parthenon. "It would severely damage Fed credibility, increase the odds of entrenched inflation and inflation expectations, and create a significant communication challenge."

Shifting the inflation goal higher from 2% to 3% or 4% would be "incredibly regressive policy," particularly for lower-income workers who will not see their earnings rise by 3% or 4% to keep up with inflation, said Michael O'Rourke, chief market strategist with JonesTrading. Moving higher from 2% would also create significant volatility for businesses looking to forecast prices for project and capital expenditures.

"Price stability allows businesses to invest in new projects with confidence," O'Rourke said. "Higher rates of accepted inflation would slow business investment and spending."

With the Fed likely digging in on its 2% goal, markets have begun to prepare for the central bank to boost rates beyond previous expectations. On Feb. 24, roughly 25% of the futures market was betting the Fed would raise the federal funds rate to between 5.5% and 5.75% by June, according to the CME FedWatch Tool, which measures investor sentiment in the Fed funds futures market. A month earlier no one in the market was betting that the rate would be that high by June.

"Interest rates will need to stay higher for longer for inflation to return to target," said Michael Hewson, chief market analyst with CMC Markets. "The reality is that we might not see rate cuts much before 2025 if the Fed wants to get back to that 2% target."