Inflation is likely to show a steep fall in 2023 while remaining above a level where the Federal Reserve feels comfortable, according to the latest Goldman Sachs forecast. The firm expects inflation, as gauged by the Fed’s preferred core personal consumption expenditures price index, to tumble from its 5.1% reading in September down to 2.9% by the end of next year. “We expect core inflation to fall significantly in 2023 for three key reasons,” Goldman economist Spencer Hill said in a client note filed over the weekend. Those factors include an easing in supply chains, a decline in rent and shelter inflation, and a substantial drop in wage gains, all of which pushed inflation to its highest level since the early 1980s this year. If Goldman’s forecast is correct, it still will leave inflation above the Fed’s 2% target, which it passed in the spring of 2021 and has remained high since. Recent months have indicated that the pace of price increases is slowing but remains high enough to propel the Fed into a series of interest rate increases totaling 3.75% since March. Fed officials currently expect core PCE inflation, which excludes food and energy prices, to fall to 3.1% in 2023 before tailing off to 2.3% and 2.1% respectively in subsequent years. For its part, Goldman thinks the market consensus of a decline to 2.7% next year is too low. “Despite our strong view that core inflation will fall, consensus forecasts still look too optimistic to us: they feature an even larger decline to 2.7% in Q4 and may not reflect the strength we expect in healthcare categories,” Hill wrote. Outside of health care, though, other signs are more encouraging. The New York Fed’s supply chain index has been on the decline and in September hit its lowest level since November 2020. Semiconductors, critical in everything from computers to cars, had been at the core of the supply chain problems. But Hill pointed out that auto microchip shipments are now 42% above their 2019 levels. On wages, Goldman expects average hourly earnings to decline from their current 4.7% year-over-year increase to 4% by late 2023, “reflecting the continued rebalancing of the labor market.” In housing, the firm also sees inflation cooling. Rents are up 7.5% from a year ago, according to Bureau of Labor Statistics data, but Goldman expects that a burst in apartment construction will help bring that number down as well. The bad news: Even with the substantial drop-off in inflation, the Fed still could feel under pressure to bring it down more. “From the Fed’s perspective on inflation, ‘falling significantly’ and ‘returning to target’ are two very different things,” Hill said. “Despite the improvement we forecast, core inflation is likely to remain well above target at every FOMC meeting next year — barring a recession or a broad-based normalization of core goods prices.” Markets widely expect the Fed to increase its benchmark interest rate by half percentage point in December, followed by a few more hikes in 2023 before the funds rate tops out near 4.75%-5% by midyear, according to CME Group data . In recent weeks, central bank officials have stressed the importance of leaving rates high until inflation shows tangible signs of decreasing back to target. Futures pricing, though, is indicating the probability of at least one quarter-point reduction before the end of the next year. —With reporting by Michael Bloom
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