Inflation is higher than expected at 6.4%, with the 'most important' measure remaining elevated

The inflation rate only dropped slightly in January — down to a year-over-year rate of 6.4%, after posting 6.5% in December. Month-to-month inflation ticked up 0.5%, after dropping in December, according to the latest consumer price index report published Tuesday morning.

Core inflation, which is the price of all items on the index except for food and energy, went up slightly to 0.4%, compared with 0.3% in December. Since food and energy prices are volatile, core inflation is seen as a better indicator of overall inflation trends.

While Federal Reserve chair Jerome Powell said in a speech last week that "the disinflationary process has begun," he warned that persistently high inflation could stay elevated in 2023.

He also said that price gains in the services sector — which includes things like dry cleaning, tax preparation and the cost of rent — remains a concern. This measure has been described by Powell as the "most important" measure of where inflation is headed in 2023.

In Tuesday's report, the cost of "services less energy services" rose by 0.5%, its third straight month of similar gains. Additionally, "services less rent of shelter" stayed steady, rising by 0.6% for the second month in a row.

These two measures suggest that inflation is not entirely driven by either volatile energy costs or rent. Rent in particular tends to lag behind other prices based on when leases are renewed.

"Services-based inflation has remained stubbornly high in 2022," says Greg McBride, chief financial analyst at financial services company Bankrate. "Because the labor market is tightest in the services sector, the Fed's concern is that labor tightness will feed inflation pressures." 

Powell said last week that continued interest rate hikes might be necessary to cool the economy if inflation is persistently higher than the year-over-year benchmark rate of 2%. Higher interest rates increase the cost of borrowing for things like cars, loans and mortgages.

Here's a look at how much costs for selected services have risen in the last year, as of January:

• Package delivery: 14.3%
• Pet-related services: 8.4%
• Hotels and motels: 7.7%
• Haircuts: 5.2%
• Laundry: 5.1%
• Gardening services: 3.2%
• Dental services: 1.7%
• Trash collection: 0.9%

Despite stubbornly high price growth, 2023 will be a year of "significant declines in inflation," Powell said last week. "My guess is it will take certainly into not just this year, but next year to get down close to 2%."

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