Key Points:
- The Consumer Price Index (CPI), a broad measure of goods and services across the U.S. economy, rose by 0.2% in August, matching the Dow Jones consensus forecast.
- This brought the 12-month inflation rate down to 2.5%, a decrease of 0.4 percentage points from July, marking the lowest level since February 2021.
- Traders now estimate an 85% chance that the Federal Reserve will implement a quarter-point (25 basis points) rate cut when its meeting concludes on Sept. 18.
- Real earnings saw an uptick, with average hourly wages surpassing the CPI’s monthly increase by 0.2%.
Inflation in August dipped to its lowest point in over three years, according to a Labor Department report released Wednesday, which also indicated a slight rise in core inflation. This has set the stage for the Federal Reserve to likely reduce interest rates by 25 basis points at their upcoming meeting.
The CPI, a key gauge of the cost of goods and services in the U.S., climbed by 0.2% in August, aligning with the Dow Jones consensus prediction, as reported by the Bureau of Labor Statistics. The annual inflation rate now sits at 2.5%, a significant drop from July’s 2.9%, slightly lower than the expected 2.6%.
However, the core CPI—which excludes the volatile food and energy sectors—ticked up 0.3%, exceeding expectations by 0.1%. The 12-month core inflation rate remained at 3.2%, matching forecasts.
This unexpected rise in core inflation could influence the Fed’s upcoming decision. While the chances of a more aggressive rate cut have diminished, traders are still pricing in a quarter-point reduction.
“This isn’t the CPI report the market wanted to see. With core inflation coming in higher than expected, the Fed’s path to a 50 basis point cut has become more complicated,” said Seema Shah, chief global strategist at Principal Asset Management.
Despite an initial dip in stock markets following the report, they rebounded later, with major indexes closing the day in positive territory. Treasury yields, meanwhile, were mixed.
According to CME Group’s FedWatch, traders have priced in an 85% chance of a 25 basis point rate cut during the Federal Open Market Committee’s meeting next week. Just a month ago, markets had leaned toward a 50 basis point cut.
“The number is certainly not an obstacle to policy action next week, but the hawks on the committee will likely seize on today’s CPI report as evidence that the last mile of inflation needs to be handled with care and caution—a formidable reason to default to a 25 basis points reduction,” Shah added.
While inflation continues to ease, housing costs remain a persistent issue. The shelter component of the CPI, which carries a significant weight in the index, rose by 0.5% and accounted for 70% of the core inflation increase. Year-over-year, the shelter index has increased by 5.2%.
Food prices nudged up by just 0.1%, while energy prices fell 0.8%. Other areas of the report included a 1% drop in used vehicle prices, a 0.1% decrease in medical care services, and a 0.3% rise in apparel prices. Egg prices notably rose by 4.8%.
Real earnings for the month also saw a gain, as average hourly earnings outpaced the CPI by 0.2%, according to a separate BLS report. Over the past year, inflation-adjusted wages have increased by 1.3%.
The Federal Reserve’s focus has recently shifted toward a slowing labor market. Job creation since April has halved compared to the previous five months, with central bankers emphasizing the importance of preventing a broader economic slowdown alongside managing inflation.
Regardless of the Fed’s decision next week, the market has already priced in lower rates. Treasury yields for both the 2-year and 10-year durations are at their lowest in over a year. Additionally, the inversion of the yield curve, a potential recession indicator, has reversed, signaling both potential rate cuts and an economic slowdown.
Wednesday’s report underscores the gradual decline of inflation, although it still remains above the Fed’s 2% target. Certain sectors, however, continue to experience price hikes.
“Although inflation has eased, it does not mean that the prices of things that people buy have actually fallen,” noted Lisa Sturtevant, chief economist at Bright MLS. “It just means that prices are not increasing as fast. In fact, U.S. consumers now are paying more than 20% more for goods and services than they were before the pandemic.”
For instance, airline fares rose 3.9% in August after declining over the previous five months. Motor vehicle insurance also continued its upward trend, increasing by 0.6% for a total 12-month rise of 16.5%. Hospital service costs grew by 0.4%, contributing to a year-over-year increase of 5.8%.
Meanwhile, falling energy prices helped moderate inflation. Gasoline dropped by 0.6% in August, part of a broader 4% decline in the energy index, which also saw fuel oil prices fall by 12.1%.
