The Fed’s next inflation test is here. How it will guide interest rates.

The Federal Reserve’s preferred inflation gauge cooled in January, if economists’ forecasts are right.

The Bureau of Economic Analysis is scheduled to release the latest reading for the personal consumption expenditures, or PCE, price index on Friday, Feb. 28, at 8:30 a.m. Eastern. Economists expect inflation rose 0.3% in January and 2.5% from a year earlier, according to a FactSet survey. By comparison, the index rose 0.3% month over month in December and measured 2.6% year over year.

While slower annual price growth should calm fears that inflation is reaccelerating, it likely won’t be enough to nudge the Federal Reserve to cut interest rates. The Fed paused rate cuts after its December policy meeting, when it lowered the federal funds rate to a current target range of 4.25%-4.50%.

Cooler inflation might not be enough to soothe shoppers, either. Americans continue to grapple with elevated grocery, housing, and auto insurance costs. Worries about rising prices and tariffs were behind recent lower-than-expected consumer sentiment and confidence readings from both the University of Michigan and Conference Board.

Economists expect that so-called core PCE, which excludes the more volatile food and energy costs, to have measured 2.6% growth in January from a year earlier, which would be a notable deceleration from December’s 2.8% pace. Core PCE inflation likely rose o. 3% month over month in January, compared with a 0.2% rate in December, according to economists’ expectations.

The gain in the Fed’s preferred inflation metric is expected to be significantly less than the latest reading of the consumer price index, reported earlier in February. Increases in hospital-services and auto-insurance costs were some of the bigger drivers that contributed to a hotter-than-anticipated year-over-year gain in of 3% in January. The Fed maintains an annual inflation target of 2%.

The aforementioned categories aren’t among the producer price index’s wholesale components, however, that are used to calculate changes in the index, writes Michael Pearce, deputy chief U.S. economist at Oxford Economics.

“The upshot is that, despite the upward surprise to the CPI, the PCE inflation data should look encouraging in January,” Pearce said. He noted that the base effects within the inflation calculations signal the year-over-year rate could fall closer toward 2% in the coming months.

PCE inflation has a much higher weighting than the CPI in healthcare, as it incorporates all spending on healthcare on behalf of consumers, not just out-of-pocket costs.

“That explains why price measures can differ markedly month to month, though trends in both tend to be similar,” Pearce said. He expects January’s core PCE to register slightly below expectations, at 2.5% growth year over year, which would be the lowest level in nearly four years. .

While PCE inflation might paint a slightly rosier picture for Fed officials, economists expect the central bank to keep interest rates on hold for some time because of the uncertain outlook for fiscal and trade policy. For instance, President Donald Trump’s tariffs on China—and his proposed levies on other countries—could further fuel inflationary pressures.

Fed policymakers left rates steady at their January meeting, after lowering the benchmark rate by a cumulative percentage point in 2024. The central bank’s rate-setting committee meets again March 18-19, but markets largely don’t expect rates to decrease until June. Markets put the odds of a June rate cut at 72%, according to CME FedWatch.

A few economists think the Fed could be done with its latest round of rate cuts entirely.

“While there has been progress on the inflation front, it is still stuck above Fed’s target,” wrote Bank of America economists in a recent global research report. The team believes the pickup in January inflation indicates the Fed cutting cycle is over, noting that political considerations also favor a pause. “If the Fed wants to minimize the risk of having to hike later, it would be prudent to not cut rates further.”

Write to Megan Leonhardt at megan.leonhardt@barrons.com and Paul R. La Monica at paul.lamonica@barrons.com