CPI Rises Mutedly as Fed Debates Size of Rate Cut

Economists are anticipating a relatively modest increase in U.S. consumer prices for August, continuing the trend of recent months. This data could play a key role in the ongoing debate at the Federal Reserve about the direction of interest rate cuts. The Bureau of Labor Statistics (BLS) is scheduled to release the latest consumer price index (CPI) figures on Wednesday. According to a Bloomberg survey, both the CPI and the "core" inflation gauge, which excludes volatile food and energy costs, are expected to show a 0.2% rise in August, mirroring July's increases.

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This forecasted rise would bring the annual growth rate of core inflation to 3.2%, a significant decline from where inflation stood just two years ago. Back then, inflation was running at a rate three times as high. These softer inflation numbers might push the Federal Reserve to consider a quarter-point interest rate cut at their upcoming meeting. However, if the data surprises to the downside, investors may anticipate a more aggressive half-point cut.

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Inflation data, while still relevant, is beginning to take a backseat to labor market conditions in terms of shaping Fed policy. Yet, with the August employment report delivering mixed signals, the upcoming inflation figures could still have a considerable influence. Economists Veronica Clark and Andrew Hollenhorst from Citigroup Inc. noted in a September 9 report that August’s CPI numbers could sway the Fed's decision on the size of rate cuts. They also highlighted that given the emerging risks in both the labor market and economic activity, even a moderately low inflation reading could be enough to justify a larger cut.

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Several specific components of the CPI report will be key to watch, as they could signal broader trends in inflation.

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Rental Inflation

One of the most closely observed areas is rental inflation. August is expected to see a decline in rental price growth, reversing the increase seen in July, which was driven by higher-than-usual price hikes in the Western U.S. In July, owners' equivalent rent (OER) in the West rose by 0.4% after two months of more modest 0.1% gains, while the rest of the country saw slower rent growth. If rental inflation slows again, it would continue a downtrend that started in June.

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Because rent and housing costs make up the largest portion of the CPI, slower growth in this area would open the door for other service categories, such as health care and air travel, to experience some price rebounds after unusual declines in July. However, even if these categories see price increases, they may not have a significant impact on overall inflation.

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Nomura economists, led by Aichi Amemiya, noted that their preferred indicator for predicting rent inflation—the BLS’s all tenant regressed rent index (ATRR)—points to further disinflation in official rent numbers. They also pointed to the ongoing high supply of rental apartments, which suggests that rent inflation is unlikely to accelerate in the near future.

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Car Insurance

Another area of interest is motor-vehicle insurance. Over the past two years, car insurance inflation has been a significant contributor to elevated services inflation, with monthly increases often in the range of 1% to 2%. However, there are now indications that these price hikes may be slowing.

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Economists at Morgan Stanley, led by Diego Anzoategui, noted in a September 5 report that car insurance companies appear to be filing for smaller premium increases with regulators. They expect this trend to continue, forecasting a more substantial slowdown in car insurance price inflation for the rest of the year. This deceleration would help ease inflationary pressures in the services sector, where insurance costs have been a persistent driver of higher prices.

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Within the broader services sector, analysts are also keeping a close eye on airline fares and hospital services prices. Both of these categories saw substantial price declines in July, and many expect to see a partial reversal of those declines in the August data.

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Apparel and Used Cars

Turning to goods, core prices for consumer goods fell 0.3% in July, marking the 13th drop in the past 14 months. This decline was driven largely by falling prices for used cars. Analysts expect a more modest decrease in August for both core goods and used-car prices. However, even if these prices continue to decline, the decreases are likely to be smaller than in previous months.

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Overall, while inflation remains well above the Federal Reserve's 2% target, the August report is expected to show that price increases are continuing to moderate. If this trend continues, it could provide the central bank with the flexibility to consider more substantial interest rate cuts in the coming months. However, with risks building in both the labor market and broader economic activity, the Fed will be closely watching not only inflation but a range of economic indicators as it navigates the path forward.

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