The five-month surge in inflation has most likely resulted in a cyclical peak, reaching 5.4% in July on the back of a 0.5% increase on the month.
We expect that top-line and core inflation metrics will fade back toward 3% in the near term and will be somewhat sticky after that.
The core Consumer Price Index excluding the more volatile food and energy components increased by 0.3% on the month and by 4.3% on a year-ago basis, according to government data released Wednesday.
Like the Federal Reserve, we prefer to focus on core rates of inflation in general and the core personal consumption expenditures metric, which is the better long-term predictor of inflation and is used by the Fed in setting monetary policy.
We expect that top-line and core inflation metrics will fade back toward 3% in the near term and will be somewhat sticky after that because of what will be an increase in rents inside the CPI and PCE measures.
The primary catalysts for the recent surge in inflation remain lodging away from home, energy and transportation, though all have eased to a more moderate pace.
The base effects in the data, or the comparisons to the low levels of the economic shutdown last year, have now faded for the most part. Investors, policymakers and firm managers should not anticipate any material impact from those base effects until next spring, when they will cause a noticeable decline in top-line year-over-year inflation.
Owners’ equivalent rent
The key metric to monitor will be the owners’ equivalent rent, which was up by 0.3% on the month and by 2.4% on a year-ago basis, because of the likely increase in imputed rents as the economy slowly normalizes in what appears to be the latter phase of the pandemic.
We use the term “latter phase” with extreme caution given the risks around the spread of the delta variant.
Near real-time indicators of spending have all pointed toward a moderation in household consumption, which is likely attributed to the delta variant’s spread among the unvaccinated. That moderation should also dampen inflationary pressures in August and into the fall.
The cost of used vehicles rose by 0.2% in July, a paltry increase compared to the 10.5% surge in June. While the CPI data shows an increase, it typically lags the Manheim used car index by about six to eight weeks. That index showed that the cost of used vehicles peaked in May and began to decline at a 1.3% pace in June and then by 1.7% in July.
With one of the major catalysts for the recent rise in inflation already in decline, and demand for hotels almost certainly to do the same this fall, one should anticipate that the long march back toward the 2% trend, which we expect to take through 2023, has begun.
Housing costs
The index for lodging away from home continued to surge, increasing by 6.0% in July after rising by 7.0% in June. Hotel rooms were up by 6.8%. As the calendar turns from summer to fall, investors should anticipate an easing in prices that, along with transportation costs, will provide relief to the recent rise in top-line prices. Airfare prices declined by 0.1% in July.
The index for lodging away from home continued to surge, increasing by 6.0% in July.
While the likely cyclical peak in inflation will permeate policy talk out of the Fed over the next few months, the data will offer little solace to policymakers who are now squarely focused on the evolution of owners’ equivalent rent, which will likely rise in the coming months.
The OER was up by 0.3% in July on a month-over-month basis and by 2.4% on a year-ago basis. Although both are in line with long-term stable trends, a sharp move higher would be much more of a challenge in bringing inflation back down to the Fed’s 2% target.
Given that discussion around reducing the pace of the Fed’s $120 billion in monthly asset purchases is rather advanced, the Fed is well positioned to begin at the very least paring back its $40 billion per month in purchases of mortgage-backed securities to cool the still-hot housing market.
Other measures
Beneath the data, energy costs rose by 1.6% while gasoline prices increased by 2.4%. Services were up by 0.3% on the month and by 3.1% on a year-ago basis. Services, which comprise 61.48% of the index, are probably the better indicator of the true trend in top-line inflation and inform our forecast for the CPI to return to near 3% by the end of the year.
Food and beverages costs were up by 0.7% in July and by 3.4% compared to a year ago, and are above the long-run trend of 2.3%.
With the traditional back-to-school shopping season arriving, apparel costs were flat in July and were up by 4.2% on a year-ago basis. Education costs, which account for 6.56% of the index, advanced by 0.2% on the month and were up by 1.1% from a year ago.
Transportation, which comprises 16.97% of the index, saw a 0.6% increase in monthly costs, while the price of new vehicles rose by 1.7%. Medical care, which accounts for 8.57% of the index, was up by 0.3% in July and by 0.3% on a year-over-year basis.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
