Inflation inside the consumer price index continued to moderate in August as the top-line figure increased by 0.2% on the month and by 2.5% on a year-ago basis.
Core inflation increased by 0.3% and 3.2%, respectively, on the back of a 1% decline in used cars and truck prices as well as an 0.8% drop in energy and a 0.6% decline in gasoline prices.
When real-time data on energy and gasoline is eventually factored In, the CPI data for September is likely to show a further moderation.
Read more of RSM’s insights on inflation, the economy and the middle market.
For the Federal Reserve, this moderation supports the idea that it has achieved its goal of price stability.
While the Fed is poised to reduce its restrictive policy rate at its next policy meeting on Sept. 18—we think by 25 basis points—it is time for the central bank to lay out a path for further reductions.
We think the terminal federal funds rate resides somewhere between 3% and 3.5%. By more clearly articulating its intentions of how much and how quickly it will cut rates, the Fed can shape market expectations and support risk taking by households and firms.
Forward-looking market pricing using the one-year inflation swap—a derivative used to manage inflation risk—stands at 1.73%, implying that inflation is on a path toward overshooting the Fed’s 2% inflation target.
The underlying trend inside the CPI points to a 2% to 2.5% inflation rate in the near term. Inflation dynamics, most notably those inside the sticky service sector and the housing sector, will have to ease further to cause such an overshoot.
Nevertheless, in our estimation price stability has been achieved and it is past time that the Federal Reserve start reducing rates and map out the destination of its journey.
The data
Service prices remained sticky and housing costs persistent, which will persuade the Federal Reserve to keep its initial rate cut to 25 basis points in contrast with calls by some for a 50 basis-point rate cut.
Energy costs are down by 4% on the year while gasoline costs have declined by 10.3% over the past 12 months. Service prices increased by 0.3% in August and were up by 4.8% from one year ago.
Housing prices were up by 0.3%, while shelter costs and the policy-sensitive owner’s equivalent rent both increased by 0.5% on the month. On a year-ago basis, housing increased by 4.4%, shelter by 5.2% and owner’s equivalent rent by 5.4%.
Food prices advanced by 0.1% and were up by 2.1%, while apparel costs increased by 0.3% on the month and the past year.
Transportation prices increased by 0.1% and were down by 1% from one year ago. While airline fares jumped by 3.9% in August, they fell by 1.3% over the past year. Medical care dropped by 0.1% on the month and were up by 3% over the past 12 months.
The takeaway
Moderation in inflation is consistent with price stability, which is supportive of businesses and households that have experienced a most difficult three years with respect to pricing.
As inflation growth further slows, this easing will bolster rising real wages, which in turn will support growth and household spending at sustainable levels.
Wage gains above inflation over the past year and a half are not firmly pushing the inflation shock into the rear-view mirror.
New data from the U.S. Census Bureau demonstrates that wages are now rising 3.5%, even when taking into account inflation. That is above 2019 levels which is supportive of households and firms that will experience an unlocking of cash flows as both nominal and real interest rates continue to decline.
