The U.S. consumer price index in July saw a meaningful increase, driven by sticky service sector pricing and tariff-induced price increases, which are all over the report.
The 0.2% monthly increase in July was held down by a 2.2% monthly decline in gasoline prices. But the index advanced by 2.7% on the year.
The broader problem was in the core figure that excludes the more volatile food and energy components. Inflation in that category increased by 0.3% on the month and by 3.1% compared to a year ago.
Core goods prices, driven by tariffs that are now showing up in the hard data, advanced by 1.2% from a year ago following a period of muted increases.
In addition, service prices excluding rent of shelter advanced by 4% on a year-ago basis, which is not well aligned with the Federal Reserve’s overall inflation target of 2%.
In recent months, businesses have pulled forward purchases of goods to get ahead of tariff-induced price increases.
But those purchases are ending. Now, businesses will face a choice between absorbing costs and accepting thinner profit margins, and passing along the cost of tariffs to customers, or both.
There are four points along the supply chain where costs can be absorbed: by exporters, importers, retailers and consumers. Given that rising import costs imply that exporters are not materially absorbing those costs, it strongly suggests that thinner margins and rising inflation lie ahead.
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One gets the sense that July’s data is one of those inflation reports that will not be well received by American consumers.
Items that consumers frequently purchase were markedly higher. Coffee increased by 2.3% on the month and by 14.8% annually, and beef and veal rose by 1.5% on the month and by 11.3% on the year.
In addition, tomatoes jumped by 3.3% in July, almost exclusively because of trade taxes on Mexican agricultural imports.
The cost of guacamole is about to rise notably.
Policy implications
The Federal Reserve will need to reconcile the tension within its dual mandate given rising inflation and a softer jobs outlook ahead of its critical policy decision on Sept. 17.
The slow burn inside the core is sure to cause a nasty case of acid reflux for policymakers who find themselves at cross purposes on the central bank’s mandates of restoring price stability and ensuring maximum sustainable employment.
At this point, with core inflation rising and the personal consumption expenditures index also increasing, the high confidence that investors have in a September rate cut seems somewhat misplaced.
For now, we will stick with our forecast of one 25 basis-point reduction at the December meeting pending the evolution of the labor market and inflation data.
The data
Energy costs dropped by 1.1% in July, which offset rising inflation elsewhere. Services increased by 0.3% and services excluding energy advanced by 0.4%, which translated to a 3.6% increase in both categories from a year ago.
Housing and shelter costs increased by 0.2% on the month while the policy-sensitive owners’ equivalent rent series increased by 0.3% on the month.
Food and beverage costs were flat on the month, apparel costs increased by 0.1%, transportation prices were flat , andused car and truck prices advanced by 0.5%.
Airline fares jumped by 4% on the month, medical care by 0.7%. recreation rose by 0.4% while commodities, education and communications prices were flat.
The takeaway
Inflation inside the core gained steam in July as goods prices continued to increase. Given that the current effective tariff rate will rise to 17.6% from 9.14% by early October, investors and firm managers should prepare for thinner margins and rising inflation.
This will keep policymakers on hold until they are certain that the pass-through of pricing is a one-time effect before cutting interest rates. And that is why we are keeping to our forecast of one 25 basis-point rate cut at the end of the year at best.
