Key Takeaways:
- August CPI Data rose 0.2% month-over-month and 2.5% year-over-year.
- Energy prices dropped 0.8%, while food inflation remained subdued.
- Core inflation increased 0.3%, driven by a 0.4% rise in services prices.
- Primary shelter inflation remains stubbornly high, while core goods prices continued to decline.
- A 25 bps rate cut is expected next week, with the potential for larger cuts in future meetings depending on labor market conditions.
August’s Consumer Price Index (CPI) data points to a potential 25 basis points (bps) rate cut at the Federal Reserve’s meeting next week. The latest inflation numbers show continued easing in food and energy prices, while inflation in services sectors rebounded. The data reflects the slow but ongoing process of unwinding pandemic-era price pressures.
Food inflation remained tame, rising by just 0.1% in August, while energy prices dropped 0.8%, driven by a 0.6% decline in gasoline prices and a steeper 1.9% fall in utility gas service. These declines helped headline inflation grow at a modest 0.2% month-over-month, keeping the annual increase at 2.5%. That brings inflation close to its per-pandemic level of 2.3% in February 2020, signaling that price pressures in key household expenses have cooled significantly over the past year.
Core Inflation Remains Sticky in Services Sector
While the headline CPI offers good news for consumers, the Federal Reserve typically focuses on core inflation, which excludes volatile food and energy prices. In August, core inflation rose by 0.3%, slightly up from July’s 0.2% increase. This bump was largely driven by an acceleration in services inflation, which grew by 0.4%, the highest since April.
The most significant contributor to this sticky inflation is shelter costs. The Bureau of Labor Statistics reported a 0.5% rise in primary shelter inflation, defying private-sector indicators that suggested a deceleration. This mismatch raises concerns about how quickly rental inflation will ease in the coming months. Travel-related services also saw notable gains, with lodging prices up 1.8% and airfares rising by 3.9%. However, these are considered more volatile components, and their influence on long-term inflation trends may be limited.
Deflation in Goods Continues Despite Used Car Market Volatility
On the other hand, core goods prices fell by 0.2%, continuing a deflationary trend. Used car prices, which dropped by 1.0%, were a key driver of the decline. Though auction data suggests that used car prices could rebound in the near term, the broader deflationary trend in goods prices shows that smoother supply chains and cooling consumer demand are keeping price pressures subdued.
Outside of autos, goods prices also softened, signaling that inflation in this sector has yet to run its course. This ongoing deflation in goods contrasts with the inflationary pressures in services, underscoring the uneven nature of price dynamics in today’s economy.
Fed’s Rate Decision: 25 bps or 50 bps?
The August CPI data, along with last week’s employment report, suggests that the Federal Open Market Committee (FOMC) is likely to opt for a 25 bps rate cut next week. However, a 50 bps cut remains within the realm of possibility, especially if policymakers weigh the slower pace of inflation against the weakening labor market.
Non-farm payroll growth has decelerated sharply, while both unemployment and underemployment rates have inched upward, raising concerns about the broader economic outlook. The labor market’s slowdown will play a crucial role in the Fed’s decision-making process as they aim to balance inflation control with supporting economic growth.
The core CPI has increased at a 2.1% annualized rate over the past three months—slightly above the Fed’s 2% target but not enough to spark concern of runaway inflation. This moderation provides enough room for the Fed to initiate a 25 bps cut, though they could accelerate policy easing with larger cuts in future meetings if labor market conditions worsen.
Outlook: Inflation and Labor Market Remain in Focus
With food and energy prices stabilizing and deflation in goods continuing, inflation appears to be trending toward the Fed’s 2% target. However, persistent inflation in services, particularly in shelter, remains a point of concern. Fed officials will closely monitor upcoming labor market data, which could determine the pace and scale of future rate cuts.
Though a 25 bps cut next week is the most likely outcome, the possibility of a more aggressive 50 bps cut can’t be ruled out if the economic outlook deteriorates further. Either way, additional rate cuts are expected in the coming months as inflation moderates and the labor market weakens, setting the stage for further monetary policy easing.
Source: WELLS FARGO
