Will core CPI fall below 2.2% in 2026?

Leading rent indices forecast future Owners' Equivalent Rent movements. Leading rent indices, such as the Zillow Observed Rent Index (ZORI), serve as forward indicators for the shelter component of the Consumer Price Index (CPI), specifically Owners' Equivalent Rent (OER) ^[1]. ZORI tracks typical changes in rent for various housing units, applying smoothing and seasonal adjustments ^[3]. While the research premise assumes a deceleration path for ZORI through Q2 2025, current data from January 2025 indicates that "rent growth holds steady," suggesting no explicit deceleration is immediately evident in the provided information ^[2].

OER changes lag market rent movements by over a year. Historically, the lag between shifts in market rents and the OER component of CPI typically ranges between 12 and 18 months ^[1]. Consequently, if ZORI were to demonstrate a sustained deceleration through Q2 2025, the year-over-year rate of OER would begin to reflect this trend approximately between Q2 2026 and Q4 2026. Therefore, by Q3 2026, the OER component would likely exhibit a decelerating year-over-year rate, mirroring the earlier market rent movements. However, without specific year-over-year deceleration figures for ZORI through Q2 2025, a precise numerical forecast for OER's rate in Q3 2026 cannot be provided ^[1].

Productivity slowed late 2025, while compensation growth remained steady. Nonfarm business sector productivity growth decelerated to 1.8% in the fourth quarter of 2025, a figure that was subsequently revised downwards ^[1]. Despite this slowdown in late 2025, the underlying trend for productivity was still characterized as solid ^[3]. Concurrently, quarterly readings for the Employment Cost Index (ECI) through the end of 2025 indicate a sustained trajectory of compensation growth across civilian workers ^[2], with additional commentary provided for the fourth quarter ^[4].

Unit Labor Costs are projected to increase into 2026. The combined trends of slowing productivity growth and ongoing compensation increases suggest continued year-over-year growth in Unit Labor Costs (ULC) as the economy enters 2026. This dynamic implies that compensation growth likely outpaced productivity gains, aligning with reports indicating that US labor costs rose "more than expected" ^[5]. Sustained ULC growth could contribute to upward pressure on prices, highlighting productivity's crucial role in powering economic growth in 2026 ^[6].

The Fed's December 2025 SEP projects a 2.5 percent longer-run federal funds rate. In December 2025, the Federal Reserve's Summary of Economic Projections (SEP) indicated a median 'longer run' federal funds rate of 2.5 percent ^[1]. This projection represents the nominal federal funds rate that Federal Open Market Committee (FOMC) participants expect when the economy reaches its full potential and inflation stabilizes at the FOMC's 2 percent target ^[1].

Real-time r-star estimates align with the FOMC's longer-run projection. The concept of r-star, also known as the natural rate of interest, denotes the real interest rate consistent with full employment and stable inflation ^[2]. While r-star is recognized as a theoretical and often debated figure ^[3], estimates derived from the New York Fed's Laubach-Williams model typically place the real r-star at approximately 0.5 percent ^[2]. When the FOMC's 2 percent inflation target is incorporated with this real r-star, the resulting nominal r-star estimate is approximately 2.5 percent ^[2]. This demonstrates a broad consistency between the FOMC's longer-run projection and the nominal equivalent of real-time r-star estimates ^[1].

The CBO projects a higher primary deficit over the next decade. Following the finalization of the FY2026 budget, the Congressional Budget Office (CBO) forecasts that the primary deficit, which represents the total deficit excluding net interest payments, will average 2.7% of Gross Domestic Product (GDP) over the 10-year period from 2027 to 2036 ^[1]. This projection is detailed in the CBO's February 2026 Budget and Economic Outlook ^[1]. While the primary deficit is anticipated to decrease from 3.3% of GDP in 2026 to 2.3% of GDP in 2036, it is then projected to begin rising thereafter ^[1].

Pre-pandemic deficits show a lower average fiscal impulse. To provide a comparative context for this fiscal impulse, an analysis of the pre-pandemic period from 2015 to 2019 reveals a lower average primary deficit. Based on CBO historical data, the primary deficit as a percentage of GDP was approximately 1.3% in 2015, 1.9% in 2016, 2.1% in 2017, 2.5% in 2018, and 3.0% in 2019 ^[2]. Averaging these figures, the primary deficit during the 2015-2019 pre-pandemic period stood at approximately 2.16% of GDP ^[2].

The projected deficit reflects a sustained higher borrowing level. The CBO's 10-year projection for the primary deficit, averaging 2.7% of GDP from 2027 to 2036, indicates a larger fiscal impulse compared to the approximately 2.16% average observed in the 2015-2019 pre-pandemic period ^[1]. This suggests that the projected decade is expected to feature a sustained higher level of government borrowing relative to the size of the economy, excluding interest costs, compared to the years immediately preceding the COVID-19 pandemic.

December 2025 Core CPI index serves as a crucial baseline. The Core CPI (CPI-U, All Items Less Food and Energy, U.S. City Average, Seasonally Adjusted) index for December 2025 was 314.274 ^[1], ^[2]. This figure is essential for calculating future year-over-year (YoY) changes. Throughout 2025, the monthly Core CPI index levels varied, starting from 310.156 in January and concluding with the December value ^[2].

A specific monthly growth rate achieves the sub-2.2% target. To determine the maximum average month-over-month (MoM) Core CPI increase that ensures at least one month's year-over-year reading falls below 2.2% in 2026, a constant MoM growth rate is assumed for Core CPI in 2026. Each month's YoY Core CPI is calculated against its corresponding 2025 base. The analysis identifies the specific MoM rate for each month that would result in exactly 2.2% YoY. The lowest of these monthly rates, approximately 0.1815% (or 0.001815), corresponds to the rate needed for December 2026's YoY Core CPI to be exactly 2.2%, thus representing the maximum average MoM increase that can be sustained ^[2].

Sustaining this rate ensures most 2026 YoY readings fall below target. If Core CPI were to increase consistently at this average rate of 0.1815% month-over-month throughout 2026, the year-over-year readings for every month from January 2026 through November 2026 would also fall below 2.2% ^[1], ^[2]. This calculated rate signifies the highest possible consistent monthly growth that still achieves the objective of having at least one month's YoY Core CPI reading fall below 2.2% ^[1], ^[2].