The pace of consumer inflation is expected to have fallen slightly in December from the prior month because of a sharp drop in gasoline and energy prices, but the annual rate is still likely to remain uncomfortably high.

According to Dow Jones, economists now expect a decline of 0.1% in the consumer price index on a monthly basis, but inflation is still expected to climb at a 6.5% rate from the prior year. That compares to a gain of 0.1% in November, and a 7.1% pace year over year. However, the CPI is well off the 9.1% peak rate in June.

Core CPI, excluding energy and food, is expected to be up 0.3% in December, gaining 5.7% on a year-over-year basis. Core CPI rose 0.2% in November and 6% on a yearly basis.

“We welcome it with open arms. It’s good news,” said KPMG chief economist Diane Swonk of the expected decline. “It’s great and it helped to fuel consumer spending in the fourth quarter. … But it’s still not enough.”

The consumer price index is expected Thursday at 8:30 a.m. ET. It is the final CPI report before the Federal Reserve’s Feb. 1 interest rate decision. For that reason, the inflation number has become a major event for financial markets, and now some traders are betting it will show inflation slowing even more than economists forecast. They also point to weaker-than-expected wage growth in December’s jobs report, as well as other data that reflects lower inflation expectations.

Stocks rallied on Wednesday ahead of the report. “The market is looking at it as glass half full. Inflation is rolling over, and the Fed is almost done raising interest rates,” said Peter Boockvar, chief investment officer at Bleakley Financial Group. “I think they remember the last two months when you had numbers that were well below expectations. They’re just assuming that’s going to be the case again.”

In the futures market, traders continued to bet the central bank will raise rates by just a quarter point at its next meeting. Meanwhile, some economists continue to expect policymakers will increase the fed funds target rate by a half percentage point. Market expectations are just 20% for a 50 basis point hike. A basis point equals 0.01 of a percentage point.

“It’s amazing how much reaction and overreaction there is for one single data point,” said Simona Mocuta, chief economist at State Street Global Advisors. “Clearly the CPI is very important. In this particular case, it does have fairly direct policy implications, which are about the size of the next Fed rate hike.”

Mocuta said a cooler CPI should influence the Fed. “The market has not priced the full 50. I think the market is right in this case,” she said. “The Fed can still contradict the market, but what the market is pricing is the right decision.”

Wilmington Trust chief economist Luke Tilley said a 12% decline in gasoline prices in December and other decreases in energy prices — for expenses like home heating — helped drive inflation lower.

“Shelter is the main focus because of the lag,” he said. Rental market data shows a slowing in rates, but the CPI has not yet reflected it. “Everyone is familiar with the lag that it takes for the data to show up in the CPI,” Tilley added. “We think there could be a sharper slowdown.” Shelter costs are 40% of core CPI.

Shelter is expected to be up 0.6% month over month. Tilley said with the decline in the real estate market, he is hearing from landlords that they are having a more difficult time raising rents. “We’re penciling in slower increases in January and February and March on that shorter lag,” he said.

Economists are watching closely to see how much inflation related to services rises in CPI, since goods inflation is expected to continue to come down now that supply chains are operating more normally.

“The headline monthly changes over the last two, three months overstate the improvement. We’re not going to get the same help from gasoline in the next report. I don’t want to see an acceleration in shelter. I want to see some of the discretionary areas show deceleration,” said State Street’s Mocuta. “I think right now the focus is very much on the services side.”

The market is laser focused on inflation since the Fed’s progress in fighting it could determine how far the central bank will go on its rate hiking path. The rate increases are slowing the economy, and how much more it chooses to do so could be the difference between a soft landing or a recession.

“The hope is that basically we are now in a position where you could envision a soft landing. That requires the Fed to not only stop raising rates but ease up sooner and that doesn’t seem to be where they’re at,” said Swonk. “The Fed is hedging a different bet than the markets are. … This is where nuance is really hard. You’re in this position where you’re improving. It’s like a patient is getting better, but they’re not out of the hospital yet.”

The fed funds rate range is currently at 4.25% to 4.5%, and the central bank has forecast a final high rate of 5.1% for this year.

“The Fed is also worried about a second round of supply shock, whether it’s China’s abrupt abandonment of its zero-Covid policy or something else from Russia. They don’t want to declare victory too soon,” said Swonk. “They’re making that very clear. They’ve said it over and over again and nobody listens.”

Economists expect another key metric — the personal consumption expenditure deflator — could show core inflation slowing even below the Fed’s forecast of 3.5% by Dec. 31. Some economists who expect a recession predict rate cuts before year-end, as the markets expect. But the Fed has no forecast for rate cuts until 2024.

Some strategists expect Fed officials to begin to sound more dovish and less at odds with the market view. Boston Fed President Susan Collins said in an interview with The New York Times on Wednesday that she was leaning toward a quarter-point hike at the next meeting.

“We think one of the changes in coming months is the Fed will soon realize it is cheaper to change the inflation narrative than reverse a recession leading to millions of lost jobs,” writes Fundstrat founder Tom Lee in a note Wednesday.