Core inflation offsets any improvement in energy prices

CPI Reaction—Core inflation offsets any improvement in energy prices in August

The Consumer Price Index (CPI) slowed slightly to 8.3 percent year-over-year in August, vs. 8.5 percent in July. In month-over-month terms, this topline inflation metric rose 0.1 percent—up from zero percent the month prior. While a decline in energy prices was a major factor in this month’s reading, inflation in other parts of the economy intensified. Indeed, in month-over-month terms core inflation rose to 0.6 percent, vs. 0.3 percent in July; and in year-over-year terms it rose to 6.4 percent, vs. 6.0 percent in July. While these readings support our view that inflationary pressures may have peaked in Q2 much work remains to be done. With the next Fed meeting a little over a week away, we continue to expect another 75-basis point hike awaits—especially in light of the exceptionally tight labor market. Ultimately, we expect the US economy to tip into recession before the end of 2022.

Insights for What’s Ahead

1. These August readings are consistent with our expectation that consumer price increases probably peaked in Q2 2022, but we maintain that high inflation will remain an issue throughout 2022 and 2023. The improvement in headline year-over-year inflation reading was largely due to falling energy prices, with a large drop in gasoline prices leading the way. However, these gains were offset by intensifying inflation in other categories. Increases in shelter, food, and medical care indexes were the largest of the many contributions to the broad price increases seen in August, according to the BLS. While there has been some recent progress in slowing inflation it is clear that much more work remains to be done.

2. Given the current inflationary environment, we expect the Fed will hike by 75 bp in September and will raise the federal funds rate to 3.50-3.75 percent by the end of the year and then up to 3.75-4.00 percent in early 2023—deep into “restrictive” territory. Even with this degree of monetary policy tightening, key consumer price indexes, specifically the personal consumption expenditure deflator, will likely remain notably above the 2 percent target (we forecast 2.7 year-on-year) by the end of 2023.

3. Borrowing costs will remain elevated in the near term as the Fed battles inflation. These two forces will weigh on consumer spending and business investment over the next 12 to 18 months and will likely trigger a US recession. Anemic growth and elevated inflation before and after this recession will exhibit stagflationary characteristics. 

August Inflation Highlights

Headline CPI eased somewhat in August, but remained near the 40-year high. On a year-on-year basis, headline inflation fell to 8.3 percent from 8.5 percent the month prior. The gauge also rose 0.1 percent in month-over-month terms, following a flat reading in July. Gasoline prices fell 10.6 percent from the prior month, but gains in many other categories offset the decline. Indeed, for the month of August food prices rose by 0.8 percent.

Core CPI intensified in August. The core index, which is total CPI less volatile food and energy prices, rose by 0.6 percent month-over-month in August, vs. 0.3 in July, 0.7 in June, and 0.6 percent in May. Indeed, shelter prices rose 0.7 percent, and medical care rose 0.8 percent. Additionally, in year-over-year terms core CPI was rose to 6.4 percent from 6.0 percent in July.