The Bureau of Labor Statistics released the December 2025 Consumer Price Index report this week, and the numbers offered a measure of relief to those worried about persistent inflation. Core CPI—which excludes volatile food and energy prices—rose just 0.2% for the month, below the 0.3% that economists had projected. On a year-over-year basis, core inflation held at 2.6%, suggesting gradual progress toward the Federal Reserve's 2% target.
The Numbers in Detail
The headline CPI figure showed a 0.3% monthly increase, pushing the year-over-year rate to 2.7%. While this remains above the Fed's target, the trajectory continues to point in the right direction. More importantly, the core measure that the Fed watches most closely came in softer than expected.
Breaking down the components reveals a nuanced picture:
Shelter: The housing component rose 0.4% for the month, remaining the largest contributor to inflation. On an annual basis, shelter costs are up 3.2%—still elevated but showing signs of moderation. Shelter accounts for more than one-third of the CPI basket, making its trajectory crucial for overall inflation.
Food: Grocery prices increased 0.7% in December, with food at home also up 0.7%. The food category continues to pressure household budgets, though the pace has slowed from the double-digit increases seen in 2022.
Energy: Energy prices rose 0.3% on the month but declined 0.5% for gasoline specifically. Year-over-year, energy is up 2.3%—a far cry from the spikes that roiled consumers in 2022.
Eggs: In a bit of good news for breakfast lovers, egg prices fell 8.2% in December after soaring earlier in the year due to avian flu outbreaks. Egg prices remain down nearly 21% from their peak.
Market and Fed Implications
Financial markets responded positively to the report, with bond yields edging lower and stock futures ticking higher. The data reinforced expectations that the Federal Reserve will hold interest rates steady at its January 27-28 meeting while keeping rate cuts on the table for later in 2026.
According to the CME FedWatch tool, traders now see a 97% probability that the Fed will maintain the current federal funds rate target of 4.00-4.25% at the January meeting. The first rate cut is not priced in until June, reflecting both continued inflation vigilance and the economy's resilience.
"This report is exactly what the Fed wanted to see," noted Diane Swonk, chief economist at KPMG. "It's not a victory lap, but it's another data point suggesting inflation is moving in the right direction."
The Shelter Puzzle
The persistent strength in shelter inflation remains the biggest obstacle to achieving the Fed's 2% target. Housing costs flow through the CPI with a significant lag—current readings reflect rental agreements signed months ago rather than today's market conditions.
Private-sector rent trackers suggest that market rents have been cooling for over a year, with some measures showing outright declines in certain markets. Eventually, this softness should filter into the official inflation statistics, but the timing remains uncertain.
"Shelter inflation is like a slow-moving ship," explained Omair Sharif of Inflation Insights. "You can see it turning, but it takes time for the direction change to fully manifest in the data."
Fed officials have repeatedly cited the shelter component as a key variable in their inflation outlook. If the anticipated deceleration materializes, overall inflation could fall more rapidly than current projections suggest.
What This Means for Consumers
For American households, the December report offers mixed comfort. While the pace of price increases has slowed substantially from the peaks of 2022, prices themselves remain elevated. A gallon of milk, a pound of beef, or a month's rent all cost significantly more than they did three years ago.
The cumulative impact of inflation continues to strain budgets, particularly for lower-income households that spend a larger share of income on necessities. Real wage gains have been modest, and many families have depleted savings accumulated during the pandemic.
"Inflation is coming down, but prices aren't," noted Mark Zandi of Moody's Analytics. "That distinction matters for how people feel about the economy even as the inflation rate improves."
The Policy Path Forward
The Fed faces a delicate balancing act in 2026. Inflation has fallen substantially from its 9.1% peak in June 2022 but remains above target. The economy continues to grow, unemployment stays low, and financial conditions are relatively accommodative despite higher interest rates.
Chairman Jerome Powell has emphasized that the Fed will be "data dependent" in determining the pace of any future rate cuts. Reports like December's CPI will be crucial inputs into that decision-making process.
The central bank's projections suggest two rate cuts in 2026, but market pricing implies potentially more—a gap that will narrow as data accumulates throughout the year. A continued moderation in core inflation would strengthen the case for cuts, while any reacceleration could push the Fed toward a more hawkish stance.
Looking Ahead
The January 2026 CPI report will be released on February 11, providing the next major data point for inflation watchers. In the meantime, focus will shift to the Fed's January meeting and any signals about the policy outlook.
For now, December's report suggests the inflation battle is progressing in the right direction, even if victory remains incomplete. The "last mile" toward the 2% target may prove challenging, but the December data provides reason for cautious optimism.
As Americans navigate an economy where prices remain high but are no longer surging, the distinction between "inflation" and "price levels" will continue to shape perceptions. The Fed's job is to address the former; the latter is a reality households must manage as best they can.
