Goldman Sachs sees inflation 'finally falling' in 2023, with core prices set to drop under 3% as wage growth slows

• Goldman Sachs said it sees a significant decline in core inflation coming in 2023.
• Improvement in supply chain disruptions, rebalancing in the labor market and easing shelter prices should bring core PCE down to 2.9%.

Easing housing prices and wage pressure will contribute to a decline in US inflation next year, with the outlook from Goldman Sachs arriving after the Federal Reserve has spent this year quickly pushing up borrowing rates to tame scorching consumer prices.

The "significant decline" in inflation in 2023 will feature annual growth in the core measure of personal consumption expenditures, or PCE, dropping to 2.9% by December next year from September's reading of 5.1%, economists at the investment bank said in a note published Sunday.

"Our forecast reflects three key factors: 1) the easing in supply chain constraints in the goods sector, 2) a peak in shelter inflation post-reopening, and 3) slower wage growth driven by the ongoing rebalancing of the labor market," wrote Jan Hatzius, chief economist at Goldman Sachs. The core PCE index, which strips out volatile food and energy prices, is the Fed's preferred inflation gauge.

The bank said supply chain disruptions have lessened and shipping congestion has loosened in 2022, with particular improvement for semiconductors as shipments for automotive microchips are 42% above 2019 levels. Meanwhile, a peak in year-over-year shelter inflation should emerge in the spring, and slower wage growth should reduce upward pressure on services inflation by late next year.

The Fed has driven up the fed funds rate by 375 basis points this year from near zero, scrambling to push down consumer price inflation that soared to 9.1% in June's reading as energy and food prices increased.

The CPI has since scaled back, but October's headline and core inflation readings of 7.7% and 6.3% remain well above the Fed's target of 2%.

Goldman Sachs said increased shipments for auto microchips have already catalyzed a 5% decline in the used car CPI and estimates another 15% drop in 2023. "We expect new car prices to begin falling as well – reflecting both higher chip supply and our finding that new cars are no longer cheaper than used cars."

From the housing front, strong demand for rental units has spurred construction or permits for 1 million apartments, creating the largest pipeline since 1974. "Rental vacancies rates are starting to rebound as a result and are likely to return to pre-pandemic rates next year."

Hatzius said rebalancing in the labor market is lowering wage growth, particularly in the retail, leisure, and other sectors that have experienced large declines in the gap between jobs and workers. "We expect year-on-year wage growth to fall by 1.5pp to 4% by late 2023, helping to slow inflation in labor-intensive services categories," he wrote.

The Fed will hold its next policy meeting on December 13-14 and investors were widely pricing in expectations for a rate hike of 50 basis points as the Fed slows the pace of its recent hikes from 75 basis points.