Inflation fell in August to its lowest level since February 2021, according to a Labor Department report Wednesday, which also showed a key gauge was higher than expected, setting the stage for an expected quarter-point interest rate cut from the Federal Reserve.
The consumer price index, a broad measure of the costs of goods and services across the U.S. economy, rose 0.2% during the month, in line with the Dow Jones consensus, the Bureau of Labor Statistics reported.
This means that the inflation rate over 12 months was 2.5%, down 0.4 percentage points from July, slightly below the 2.6% estimate and the lowest level in three and a half years.
However, the core CPI, which excludes volatile food and energy prices, rose 0.3% during the month, slightly above estimates of 0.2%. The 12-month core inflation rate held steady at 3.2%, in line with expectations.
The slight rise in core CPI keeps the Federal Reserve on the defensive against inflation, likely negating the possibility of more aggressive interest rate hikes when policymakers meet next Tuesday and Wednesday.
“This is not the CPI report the market wanted to see,” said Seema Shah, chief global strategist at Principal Asset Management. “With core inflation higher than expected, the Fed’s path to a 50 basis point rate cut has become more complicated.”
Stocks fell after the report, while Treasury yields were mixed. However, the market rebounded later in the day, recovering its losses after all major averages turned positive.
In the Federal Reserve Funds futures market, traders are pricing in an 85% chance that the Federal Open Market Committee will agree to cut rates by a quarter percentage point, or 25 basis points, when it concludes its meeting on Sept. 18, according to the CME Group’s FedWatch gauge. A month ago, markets were pricing in a 50 basis point rate cut.
“This number certainly doesn’t pose an obstacle to policy action next week, but hawks on the committee are likely to seize on today’s CPI report as evidence that the last mile of inflation needs to be handled carefully and cautiously — a strong reason to hold off on a 25bp cut,” Shah added.
Although the figures showed that inflation continued to slow slowly, housing costs remain a problem. The shelter component of the CPI, which accounts for about a third of its weight in the index, rose 0.5%, accounting for about 70% of the core increase. The shelter index rose 5.2% on a year-on-year basis.
Food prices rose by just 0.1%, while energy costs fell by 0.8%.
Elsewhere in the report, used vehicle prices fell 1 percent, health care prices fell 0.1 percent, clothing prices rose 0.3 percent and egg prices rose 4.8 percent.
Real earnings also rose during the month, with average hourly earnings outpacing the monthly increase in the Consumer Price Index by 0.2%, according to a separate statement from the Bureau of Labor Statistics. On a 12-month basis, inflation-adjusted average hourly earnings rose 1.3%.
But lately, the Fed’s attention has turned to the labor market slowdown. Job creation has slowed since April to roughly half what it was in the previous five months. Central bankers say preventing a broader slowdown is now as important as combating inflation, which in the summer of 2022 hit its highest level in more than 40 years.
Regardless of what the Fed decides when it concludes its meeting next Wednesday, markets are already pricing in lower interest rates. Treasury yields, particularly on the two- and 10-year bonds, are at their lowest levels in more than a year. The recession indicator known as an inverted yield curve has also recently reversed, a move that often heralds a rate cut by the Fed as well as a slowing economy.
10 year treasury bond yield
Wednesday’s report offered more evidence that inflation is easing, though it remains above the Federal Reserve’s 2% target. There are pockets where prices have remained elevated or turned higher.
“Even though inflation has fallen, that doesn’t mean that the prices of things people are buying have actually fallen,” said Lisa Sturtevant, chief economist at Bright MLS. “It just means that prices aren’t rising as fast. In fact, American consumers are now paying more than 20% more for goods and services than they did before the pandemic.”
Airfare prices, for example, rose 3.9% in August after falling for the previous five months. Motor insurance continued to rise, rising 0.6% to push the 12-month increase to 16.5%. Hospital and related service costs jumped 0.4%, up 5.8% from a year ago.
Meanwhile, falling energy costs have helped to push down inflation figures. Gasoline fell 0.6% in August and is now 10.3% below its level a year ago, part of a 4% decline in the energy index that included a 12.1% drop in fuel oil prices.
