The US Labor Department reported on Wednesday that the July Consumer Price Index (CPI) showed a moderate overall trend, with the core inflation rate dropping to its lowest level in over five years. This development has somewhat reduced the urgency for the Federal Reserve to raise interest rates at its September meeting. However, concurrently released wage data revealed that workers' real purchasing power continues to decline. Coupled with recurrent geopolitical conflicts in the Middle East driving up energy prices, the outlook for US inflation remains highly uncertain.
Specifically, the July CPI rose 0.1% month-over-month, a rebound from the 0.4% decline in June, which was the first monthly drop in six years. On an annual basis, the headline inflation rate slowed slightly to 3.4%, down from 3.5% in June. Excluding volatile food and energy prices, the core CPI increased 0.2% month-over-month, recovering from flat readings in June. Annually, core inflation rose 2.5%, not only falling below June's 2.6% figure but also matching the slowest pace since March 2021. Both these figures aligned with economists' median expectations.
In terms of contributing factors, housing costs remained the primary driver of price increases in July. The housing price index rose 0.1% month-over-month, accounting for nearly two-thirds of the overall price gain. Food prices edged up 0.1% overall, but with significant internal divergence: the index for food away from home rose 0.3%, while prices for food at home declined for the first time since March. Notably, influenced by a cyclosporiasis outbreak, lettuce prices posted their largest-ever drop, contributing significantly to the moderation in food costs.
In other areas, energy price trends in July showed a clear "contradictory" pattern. Gasoline prices fell 2.9% month-over-month, and electricity prices were nearly flat, rising just 0.1%, which helped to suppress the overall inflation reading. However, this decline is likely a "rearview mirror" phenomenon. The ceasefire agreement between the US and Iran collapsed in July, with hostilities reigniting and pushing the national average gasoline price back above $4 per gallon, although its monthly average was still lower than in June. Energy market heating has become more pronounced in August. On the day of the CPI report's release, Brent crude oil futures touched $90 per barrel, and US WTI crude approached $84. Economists warn that while the US, as a net oil exporter, has partially buffered the price shock from Middle East conflicts through releases from the Strategic Petroleum Reserve, this buffer is unlikely to be sustained indefinitely. Future replenishment of oil inventories by the US and other countries could keep oil prices elevated for an extended period, thereby pushing consumer energy costs higher in subsequent months.
In the goods sector, prices for core commodities, excluding food and energy, rebounded in July after two consecutive months of decline. The surge in prices for computer and related products was particularly notable. Computer software and accessories prices soared 21.2% year-over-year, marking the largest increase on record. Prices for computers, peripherals, and smart home assistants also reached their highest levels in over four years. Economists attribute this to a widespread shortage of memory chips driven by the global wave of data center construction. The impact of price increases announced in June for popular consumer tech products like Apple Inc (NASDAQ: AAPL) Mac computers and iPads is now becoming evident in the data.
Regarding services, the sub-index excluding energy and rent edged up 0.2% month-over-month, reversing its decline from the previous month. Prices for airline tickets, healthcare, communications, education, and entertainment all rose in July. However, motor vehicle insurance prices were among the few major indices to decline during the month.
Fed Policy Outlook: A Hawkish-Dovish Battle in Wait-and-See Mode
This moderate inflation report, combined with the unexpectedly weak employment data released earlier, has significantly impacted market pricing of the monetary policy path. Following the report's release, US stock index futures rose, and Treasury yields fell, as investor bets on a rate hike at the Fed's September 15-16 meeting notably diminished. According to the CME Group's FedWatch Tool, the market-implied probability of a September rate hike was around 46% before the data release but dropped to 36% after the CPI report. The Fed's benchmark interest rate currently stands in the 3.50% to 3.75% range. The Fed has held rates steady since the US initiated military action against Iran, even as major central banks like the European Central Bank and the Bank of Japan have started hiking. Fed Chair Kevin Warsh is scheduled to speak at the annual Jackson Hole symposium later this month, and investors will be scrutinizing his remarks for policy signals. Policymakers will also see the August employment and inflation reports before the September meeting.
However, there is no unanimity within the Fed. Cleveland Federal Reserve Bank President Beth Hammack took to social media on Tuesday to explicitly call for action. "It is time to act," she wrote. "The longer we wait to bring inflation back to the 2% target, the more challenging the task of containing it will become, and the higher the cost for the American people." This hawkish stance contrasts with the views of some colleagues who believe further deliberation is needed on the risks of slowing inflation versus a weakening job market, leaving the final decision for the September meeting uncertain. Additionally, attention should be paid to upcoming methodological changes for various price indicators. The Bureau of Economic Analysis will implement changes in September to the calculation of certain categories within the Personal Consumption Expenditures (PCE) price index, including legal services, computer software, and investment advisory fees. The Fed prefers the PCE-based inflation gauge, and core PCE has been rising faster than core CPI for much of this year.
Shrinking Real Wages Undermine Consumer Confidence
Despite the apparent moderation in the July CPI data, the report offers little genuine relief for the average US consumer. Another report released concurrently by the Labor Department showed that price increases continue to outpace wage growth. After accounting for inflation, real average hourly earnings fell 0.2% year-over-year in July. This measure of residents' real purchasing power has been showing a series of weak readings since the outbreak of the Iran conflict. The unadjusted average hourly earnings grew at an annual rate of 3.2% in July, significantly lagging behind the 3.4% increase in consumer prices. The high cost of living is steadily eroding public satisfaction with the economic outlook. This discontent has already manifested in the political arena and could influence the Republican Party's prospects in the November midterm elections for control of Congress. President Trump, who won the 2024 election on a promise to lower inflation, now faces increasing pressure from voters experiencing sustained real income erosion. In an interview released Monday evening, Trump blamed Iran as a "sly negotiator" and described his options for dealing with the current conflict—either "wait and see" for Iran's economy to collapse or impose "very, very severe" strikes on Iran. The interplay between the war's trajectory and oil prices constitutes a key source of uncertainty that will shape the US economic and political agenda in the coming months.
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