The US consumer prce index (CPI) climbed 3.4% year-on-year in December, up from 3.1% in November and above the market estimate of 3.2%. The surprise jump in CPI was driven by energy and food prices, which fell at a slower pace in December than a month earlier.

Core CPI, which excludes food and energy and is considered a more reliable gauge of inflation trends, dipped to 3.9% in December, lower than the 4.0% gain in November and the market estimate of 3.9%.

On a monthly basis, CPI rose to 0.3%, up from 0.1% in November and above the market estimate of 0.2%. Core CPI was unchanged at 0.3% and matched the market estimate.

The Federal Reserve pays more attention to Core CPI the headline release and will be encouraged by the decline to 3.9%, which is the lowest level since May 2021. The Fed’s steep rate-tightening cycle has pushed inflation down significantly – just one year ago, inflation was running at a hot 6.5% clip and the Fed has chopped that in half.

At the same time, the battle to bring back inflation to the 2% target will be a challenge, as inflation is dropping more slowly than it was a year ago. Interest rates have very likely peaked, as the Fed signaled in December that it would lower rates in 2024. This was a significant pivot for the Fed, which for months had insisted that rates could go even higher if inflation reversed directions and moved higher. What the Fed has failed to do is provide a timeline for rate cuts, which has investors frustrated. The markets have priced in up to six rate cuts this year, with the initial rate cut expected in March.