Even if the US annual inflation rate has slowed to 3%, this won’t prevent another rate hike in July

Autor: Financial Market
2 min

The report on consumer price inflation in June surprised the markets and investors: both the headline inflation rate and the core inflation rate (excluding food and energy) increased by 0.2% compared with the previous month, rather than by 0.3% as expected.

To 3 decimal places, it is actually 0.180% for headline inflation and 0.158% for core inflation.

This means that the annual inflation rate has slowed from 4% for overall inflation CPI to 3%, while core inflation has fallen from 5.3% to 4.8%.

Month over  month levels of just below 0.2% are exactly what is needed to bring annual inflation back to 2% in the long run, so this is good news.

However, this needs to happen consistently for the Federal Reserve to ease, and it is unlikely that the Fed will raise rates by another 25 basis points on July 26.

inflation rate

Looking at the details, the main area of upward pressure remains in housing costs, with owner equivalent rent up 0.4% month-over-month and primary rent up 0.5%. The good news is that this increase will slow rapidly in the second half of 2023 given the lags in observed rents.

Core non-residential services offer real encouragement
Aside from housing, all other sectors were weak, with only apparel (+0.3%) and gasoline (+1%) among the major subcomponents that were above 0.2% month-over-month.

Food, leisure, and raw materials all rose by only 0.1%. Prices for new vehicles and medical supplies were 0%, used vehicle prices were down 0.5%, and airline ticket prices fell 8.1%.

The Fed is focused on removing all inflation threats and is obsessed with services (excluding energy), fearing that wage pressures will remain high due to tight labour markets in this area.

Since labour costs are the biggest input for companies in this sector, and demand for these services remains fairly strong, this could keep price pressures up for longer. However, the monthly inflation rate was below 0.2% and the annual rate slowed to 3.7% from 6.6% in September.

Another tick higher, then another drop in the annual inflation rate
Unfortunately, headline annual inflation is likely to rise again in the coming months, albeit only slightly. This will be mainly due to the fact that the 0% and 0.2% readings in July and August last year will fall out of the annual comparison.

Core inflation will not have this problem, as 0.3% and 0.6% were measured in the same periods last year, making it more likely that the annual core inflation rate will slow further in July and August.

With the housing market slowing sharply based on observed rents and used car prices continuing to decline based on auction prices, the markets are increasingly confident that the annual core inflation rate CPI will be below 3.5% by year-end, while headline inflation could be around 2.5%.

This is certainly not enough to prevent a rate hike in July, given the Fed’s current position, but it does suggest that there is less need for the second rate hike it is currently hinting at.