CPI Inflation Bounces Back to its Recent Trend

The Consumer Price Index (CPI) rose by 0.2% in July, following a rare 0.1% decline in June. This modest increase met market expectations, offering some relief after recent inflation data volatility. Over the past year, headline CPI climbed 2.9%, marking the smallest annual increase since March 2021. The core CPI, excluding food and energy, also saw a 0.2% uptick, pushing its annual rise to 3.2%.

The underlying details of the report show the continuation of a number of important trends. Core goods prices fell 0.3% in July and are now down 1.9% year-to-year. Used car prices tumbled 2.3% in July, following a 1.5% drop the prior month and are now 10.9% lower than they were a year ago.

Inflation continues to moderate in line with expectations, setting the stage of lower rates.

Core services, including shelter, motor vehicle insurance, and medical care, rose 0.3% in July. Service prices continue to be driven higher by rising costs for shelter and transportation services, which both rose 0.4% in July. Prices for medical care services eased 0.3%, driven by a 1.1% decline in hospital services. Despite this, the overall medical care sector remain up 3.2% year-to-year and remains a significant contributor to overall inflation.

Shelter costs remain the biggest hurdle to bringing down inflation. Shelter costs remained stubbornly high in July, with the shelter index rising by 0.4%. This category accounted for nearly 90% of the overall CPI increase. The acceleration in shelter costs was broad-based, impacting tenant rents, owners’ equivalent rent, and lodging away from home. Residential rent, in particular, continues to prove uncomfortably persistent, rising 0.5% in July and climbing a cumulative 24.5% from its pre-pandemic level. High housing costs have likely kept renters in apartments longer, putting upward pressure on renewal rents.

Core services prices are proving resilient, largely due to persistent pressure on shelter costs.

Over the past year, core services are up 4.9%, with transportation services cost surging 8.8% and shelter climbing 5.1%. The persistent rise in core services prices, which are driven by both an overall shortage of housing, higher labor costs, and, in the case of insurance, some catch up from COVID-related price hikes, is a key variable the Federal Reserve continues to monitor closely. The unusual aspects of the post pandemic era have likely meant that the lags between changes in monetary policy and their impact on economic growth and inflation have changed, which is a subject certain to be discussed at the upcoming Jackson Hole monetary policy conference.

The energy index remained flat in July, following two consecutive months of decline. Gasoline prices were unchanged, while electricity and fuel oil posted modest gains. However, seasonal factors put downward pressure on the overall energy index in July. Looking ahead, these factors will reverse in August, potentially boosting the CPI and adding an element of uncertainty to what will be the final inflation reading before the September FOMC meeting.

Food prices rose by 0.2% in July, maintaining the pace seen in June. Grocery store prices rose 0.1% but the underlying data were mixed, with meats, poultry, fish, and eggs increasing, while cereals, bakery products, and dairy saw slight declines. The consistent rise in food prices underscores ongoing inflationary pressures within this category. Prices at restaurants rose 0.2% in July and are up 4.1% over the past year.

The Fed is likely satisfied with the latest CPI print. Our analysis of the CPI and PPI components hints at a downside surprise for the PCE deflator later this month, with the core PCE deflator rising only 0.1% after rounding down. Despite this, we maintain our forecast for just two quarter-point cuts this year, followed by 2 more in 2025.