An important inflation gauge released Friday showed that the rate of price increases cooled as 2023 came to a close.

The Commerce Department’s personal consumption expenditures price index for December, an important gauge for the Federal Reserve, increased 0.2% on the month and was up 2.9% on a yearly basis, excluding food and energy. Economists surveyed by Dow Jones had been looking for respective increases of 0.2% and 3%.

On a monthly basis, core inflation increased from 0.1% in November. However, the annual rate declined from 3.2%. The 12-month rate is the lowest since March 2021.

Including volatile food and energy costs, headline inflation also rose 0.2% for the month and held steady at 2.6% annually.

The release adds to evidence that inflation, while still elevated, is continuing to make progress lower, possibly giving the Fed a green light to start cutting interest rates later this year. The central bank targets 2% as a healthy annual inflation rate.

Markets took little notice of the data, with stock futures indicating only a slight change at the open and Treasury yields mostly lower.

“Inflation dynamics inside the metric that the Fed uses to formulate policy strongly imply that the central bank will hit its inflation target in the near term,” said Joseph Brusuelas, chief economist at RSM. “This will create the conditions in which it makes [its] policy pivot and begins a multiyear campaign in which it reduces the policy rate towards a range between 2.5% and 3%.”

The Fed’s benchmark overnight interest rate is currently targeted between 5.25%-5.5%.

As inflation drifted closer to the Fed’s target, consumer spending increased 0.7%, stronger than the 0.5% estimate. Personal income growth edged lower to 0.3%, in line with the forecast.

The data indicated that consumers are dipping into savings to pay for their expenditures. The personal savings rate fell to 3.7% for the month, down from 4.1% in November.

Within the inflation numbers, prices for goods declined by 0.2% while services prices rose by 0.3%, reversing a trend when inflation began to spike. As the pandemic forced people to stay home more, demand for goods spiked, adding to supply chain problems and exacerbating price increases.

Food prices increased 0.1% on the month while energy goods and services rose 0.3%. Prices for longer-lasting durable goods such as appliances, computers and vehicles decreased 0.4%.

Looked at in conjunction with a separate report Thursday showing that gross domestic product grew at a much faster-than-expected 3.3% pace in the fourth quarter, the most recent round of data shows an expanding economy and inflation at least moving back to the Fed’s 2% annual target.

While the public more closely follows the Labor Department’s consumer price index, Fed policymakers prefer the PCE because it adjusts for shifts in what consumers actually buy, while the CPI measures prices in the marketplace.

Inflation has been a nettlesome problem since the early days of the Covid pandemic, when price increases surged to their highest levels since the early 1980s. The Fed initially expected the acceleration to be temporary, then responded with a series of interest rate hikes that took its benchmark rate to its highest in more than 22 years.

Now, with the inflation rate cooling markets largely expect the Fed to start unwinding its policy tightening. As of Friday morning, futures traders were assigning about a 53% chance the Fed will enact its first rate cut this cycle in March, according to CME Group data. Pricing points to six quarter-percentage point decreases this year.

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