Inflation continued to moderate in July as both top-line and core inflation increased 0.2%; top-line inflation increased 2.9% from one year ago and core inflation advanced 3.2%. The internals of the report released by the Bureau of Labor Statistics on Wednesday tend to suggest that there will be further relief in the offing, as housing and service inflation has plenty of room to ease further in the second half of the year.
Our sense is that the cumulative improvement in the overall inflation data over the past year now gives the Federal Reserve cover to move into risk management mode with the intent of protecting and preserving the soft landing. That is supportive of risk assets and the release of pent-up demand from firms that have held off critical productivity enhancing investment in equipment, software, and intellectual property.
Thus, this data supports a Fed that is looking to relax its too restrictive policy rate, which currently sits in a range between 5.25% and 5.5% and supports our call for the central bank to reduce its federal funds rate by 25 basis points at its Sept. 18 meeting.
The data
Services, which comprise 64.3% of the overall weight in the consumer price index, increased 0.3% on the month and increased 2.4% on a three-month average pace. This indicates just how constructive the improvement in the inflation data has been following the noise at the outset of the year and the 4.9% year-ago increase in that metric. Services excluding energy advanced 0.3%, up 4.9% over the past year and is also advancing at a 2.4% the month average pace. All of this should, along with much of the other CPI data, give policymakers the fuel they need to make the long-awaited policy pivot toward lower interest rates.
Speaking of fuel, energy costs were flat on the month and are up 1.1% on a year ago basis, which is best reflected in the flat reading on gasoline costs that are down 2.2% from one year ago.
What is a bit more challenging is that housing, shelter and policy-sensitive owners’ equivalent rent all increased 0.4% in July and are up 4.4%, 5.1% and 5.3% from one year ago. The good news within that data is that rent of shelter on a year-ago basis eased from 3.046% to 2.986% and that easing should become more prominent in the data going forward. We do expect further easing in these critical metrics going forward which will partially mitigate the base year effects that we expect to observe in the goods sector following the large declines in 2023.
The improvement in food prices and food and beverage costs both increased 0.2% and are up 2.2% from one year ago. Apparel prices declined 0.4% in July and are up 0.2% from a year ago, while transportation costs declined 0.1% for the month and are up 1% over the past year.
New vehicle costs dropped 0.2% in July and have declined 1% from one year ago, while, used cars and trucks dropped 2.3% and are off 10.9% over the past 12 months. Airline fares dropped 1.6% and are down 2.8% over the past year.
Medical care prices dropped 0.2% and have advanced 3.2% from one year ago, while education and communications prices are up 0.2% and 0.9% over the past year.
The takeaway
The long-awaited policy pivot by the Fed is now within reach as inflation continues to ease. Based off this week producer price index and CPI data, we now expect the more important inflation aggregate—the personal consumption expenditures price index—will advance 0.18% and 2.57% from one year ago while the core metric will increase 0.17% and 2.68%, both of which will lock in that rate cut that investors have now priced in.
The tone and tenor of the inflation data outside the housing complex was both constructive and encouraging and we anticipate further easing in the housing data, which was the primary reason for the soft 0.2% increase on the month and the 2.5% pace over the past six months.
From our point of view, the policy objective of price stability is now within reach and the time for the Fed to begin easing its too restrictive policy rate is upon us.
Read the latest issue of RSM’s The Real Economy for Chief Economist Joe Brusuelas’ take on the need for rate cuts that prioritize growth.
