Inflation dwindled in August to its lowest level since February 2021, but signals of inflation remaining stubbornly sticky in some sectors likely clarified how big next week’s impending interest rate cut from the Federal Reserve will be.
The Consumer Price Index (CPI), gauging the prices of goods and services across the economy, rose 0.2% for the month, following a similar increase one month prior. The gain, which was in line with economists’ forecasts, put annual inflation at 2.5%, down from 2.9% in July to bring it to its lowest point in more than three years.
The headline CPI figure was helped by weak food price growth and sliding energy prices (led by a 0.6% retreat in gasoline prices and a 1.9% drop in utility gas costs) in August. On the other hand, core CPI — which excludes volatile food and energy prices — increased 0.3% for the month, moderately higher than the 0.2% upswing forecast by economists because of stronger-than-expected inflation in the services sector.
For one thing, a strong rebound in travel prices, including airfares and lodging, drove services inflation upward. As did primary shelter costs, a sector in which disinflation has come glacially slowly — even considering the usual lag thanks to how shelter pricing data is reported.
The modest speedbump in the core CPI didn’t necessarily undercut the expected trajectory of disinflation, per se; after all, the 12-month core inflation rate was 3.2%, in line with forecasts from Dow Jones. But while Sam Williamson, senior economist at First American Financial Corp., said that “August CPI data likely reinforces the markets’ belief that the Fed can prioritize maximum employment over price stability going forward,” he also noted that it very likely shut the door on a 50-basis-point slashing of the Fed’s benchmark rate.
“The likelihood of a 25-basis point cut next week has jumped to 85.0%, aligning with the Fed’s base case,” Williamson said.
“Meanwhile, markets are split on whether the Fed will cut rates by 100 or 125 basis points by year-end, with the former slightly favored after today’s CPI data. Assuming a 25-basis point cut in September, the Fed would then need to follow with rate cuts of additional 75 or 100 basis points respectively in November and December.”
“The biggest sticking point remains housing,” Williamson noted. “Owners’ equivalent rent was up 0.5% on a monthly basis and 5.4% annually. Everything else has returned to pre-pandemic trends.”
Wells Fargo is expecting a 25-bps cut as well, though it left open the possibility of the Fed surprising with a larger reduction.
“The combination of today’s CPI report, last Friday’s employment report and recent communication from key Fed officials leads us to believe that the [Federal Open Market Committee] will reduce the federal funds rate by 25 bps at its meeting next week,” wrote the bank’s economists in post-CPI commentary. “That said, we would not be completely shocked if the FOMC opted for a 50-bps rate cut instead. Nonfarm payroll growth has slowed significantly in recent months, and the upward trend in the unemployment and under-employment rates is concerning. The pickup in core CPI inflation from July to August is unwelcome news for those hoping for a larger cut next week, but the underlying trend in price growth remains down in our view.”
