(Bloomberg) -- As Federal Reserve officials stare down the last mile in their campaign against inflation, one key question is becoming increasingly central to the debate: Will goods prices continue to fall?

Lower prices for everything from apparel to used cars were a major driver of the faster-than-expected downdraft in inflation in the second half of 2023, and a slower pace of price declines since then has contributed to higher readings so far over the first several months of 2024.

Whether supply chains are fully healed from pandemic and war-related disruptions or not has policymakers divided on the outlook. Fed Chair Jerome Powell suggested last week that “we could get more” improvement and thus lower prices. Some of his colleagues seem more skeptical.

“The real wild card on the inflation outlook is the goods side of the equation,” said Scott Anderson, chief US economist at BMO Capital Markets. “It will continue to keep the Fed cautious.”

Fed officials at their April 30-May 1 policy meeting left their benchmark interest rate unchanged at a 23-year high and signaled a later start to rate cuts than previously anticipated after disappointing inflation readings in the first quarter.

Minutes of the gathering published Wednesday underscored the importance of developments on the goods front: “While supply chain improvements had supported disinflation for goods prices over the previous year, participants commented that an expected more gradual pace of such improvements could slow progress on inflation,” the record showed.

Car Prices

A measure in the consumer price index of so-called core goods, excluding food and energy, rose in February for the first time in nine months, in part due to an increase in prices of used cars. New- and used- car prices have since been falling, and some economists expect that to continue given weaker demand due to high interest rates, as well as greater supply.

Another category with a substantial weight in the CPI is apparel, which advanced in each of the last three months. April’s monthly increase alone was the largest since June 2020.

Meanwhile, prices for household furnishings have reliably fallen for the past year, unwinding the rapid increases during the pandemic when consumers invested heavily in home renovations. In those times, when demand was high and supply was strained, logistics often failed to keep up and delivery times dragged out for months.

Now, those factors appear to have largely normalized: The New York Fed’s Global Supply Chain Pressure Index — which brings together 27 variables that take the temperature of everything from cross-border transportation costs to country-level manufacturing data — has eased over the past year, after surging to record levels in late 2021.

Still, many on Wall Street are optimistic that core goods prices can continue moving lower in the months ahead amid ongoing improvements on the supply side of the economy and moderating demand pressures. While the CPI measure has now come down 1.6% since peaking in May 2023, it’s still up 14.3% since February 2020.

Morgan Stanley economists led by Ellen Zentner have zeroed in on just three categories responsible for the recent slowing in goods deflation in the Fed’s preferred inflation gauge, the personal consumption expenditures price index: apparel, video tapes and computer software. They noted strengthening supply chains and deflation in China were reasons to expect prices to drop further.

“There is no evidence of broad acceleration, and the story looks more like a temporary adjustment of relative prices,” the Morgan Stanley team said in a mid-year outlook report published earlier this week.

Target Corp. said this week it plans to reduce prices on around 5,000 items including groceries and other essentials, while competitor Walmart Inc. is using rollbacks to charge less for food. Grocery-chain Aldi Inc. and McDonald’s Corp. are also trying to win over consumers with discounts.

But other data point to prices rising. A measure of business input prices tracked by S&P Global rose this month, driven by factory costs that advanced at the fastest rate since November 2022. That coincides with a recent rally in commodities that’s sent prices soaring for gasoline as well as various metals and agricultural products.

“What’s interesting is that the main inflationary impetus is now coming from manufacturing rather than services, meaning rates of inflation for costs and selling prices are now somewhat elevated by pre-pandemic standards in both sectors to suggest that the final mile down to the Fed’s 2% target still seems elusive,” Chris Williamson, chief business economist at S&P Global Market Intelligence, said in a statement.

What Bloomberg Economics Says...

“We think core goods will continue to exert disinflationary momentum through the summer — serving as the key driver of disinflation. But that force will begin to wane thereafter. For disinflation to continue, housing and core services ex-housing have to pick up the baton, because year-over-year core goods inflation will likely be adding to inflation in 2025, given the low base effects this year.”

— Anna Wong, chief US economist

Fed officials want to believe the trend lower can continue. Powell on May 14 said we could still see “the final parts of supply chains really getting sorted out,” pointing to surveys of businesses that “still say there are shortages.” His second-in-command, Philip Jefferson, said Monday he’ll be watching the incoming data to see “how much more help” the supply side can provide.

But others sound less sanguine. Atlanta Fed President Raphael Bostic said Tuesday he’s “not hearing a lot about supply-chain issues” anymore, while Cleveland Fed chief Loretta Mester on May 16 said “we are not likely to get as much help on inflation from the supply side as we saw last year.”

Officials at their meeting earlier this month also noted upside risks: “Some participants pointed to geopolitical events or other factors resulting in more severe supply bottlenecks or higher shipping costs, which could put upward pressure on prices,” the minutes said.

Read More: Minutes Show Officials Rallying Around Higher-for-Longer Rates

Neil Dutta, head of US economics at Renaissance Macro, says the goods deflation trend has more room to run. He expects clothing prices to drop in the coming months as inflation-adjusted sales have been weak, and argued that “the deflation in new vehicles is only just starting” in a note earlier this week.

“The slowing in core goods inflation is not over,” Dutta said. “This is worth highlighting since an important rationale behind the hawkish narrative is that the tailwind from goods has run its course. I am not so sure.”

--With assistance from Steve Matthews.

(Updates with S&P Global data, Target earnings beginning in fourteenth paragraph.)

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