US: Inflation Pressures Ease in July, But Remain at 40-Year High

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Consumer price inflation was flat in July after having increased by 1.3% month-over-month (m/m) in June. On a year-over-year basis, inflation decelerated 0.6 percentage points (pp) from June, rising by 8.5%.

After making sizeable contributions in each of the last two months, energy prices fell by 4.6% m/m, as both gasoline (-7.7% m/m) and energy services (-11% m/m) were lower on the month. Food prices accelerated by 1.1% m/m and are now up 10.9% y/y.

Core inflation (excludes volatile items such as food and energy) rose 0.3% m/m – four-tenths slower than in June. On a year-over-year basis, core inflation is up 5.9% y/y, unchanged from the month prior.

Price growth across services (0.4% m/m) remained relatively broad-based, but did decelerate from June’s gain of 0.7% m/m. Shelter costs were again a meaningful contributor, rising 0.5% m/m. Medical care services (0.4% m/m) were also higher on the month, while transportation (-0.5% m/m) fell – largely the result of a sharp pullback in airfare (-7.8% m/m) prices.

Core goods prices – includes all goods except food & energy – were up 0.2% m/m, a sharp declaration from June’s gain of 0.8% m/m. Gains were seen in new vehicle prices (0.6% m/m), household furnishings (0.6% m/m) and recreation goods (0.2% m/m), while used vehicle prices (-0.4% m/m) and apparel (-0.1% m/m) were lower on the month.

Key Implications

Overall, slightly better than expected. Forecasts were calling for some moderation in the headline measure given the recent pullback in energy prices, but the sharper deceleration in core inflation came as pleasant surprise. However, we have been head-faked before by what appeared to be a cooling in the core measure, only to see things U-turn higher in subsequent months.

We’ve received a smattering of various wage metrics over the last few weeks, and all are showing wage growth having considerable staying power north of 5% (annualized). This is roughly two percentage points above what is consistent with the Fed’s 2% inflation objective, highlighting the uphill battle the FOMC faces. Even if core inflation shows a definitive sign of rolling over in the coming months, it won’t be until the supply-demand mismatch in the labor market eases allowing wage growth to decelerate that we’ll see inflation move meaningfully lower.

With the FOMC dropping its forward guidance and moving to a data dependent “meeting-by-meeting” assessment, today’s inflation data alongside July’s strong employment report will give policymakers little reason to materially dial back on the pace of rate hikes when it next meets on September 20th-21st. While we still see a 50bps move as the most probable outcome, another 75bps hike can’t be completely ruled out, particularly if we see further surprises on either the employment or inflation readings for August.