July inflation eased somewhat, but remains high

The Consumer Price Index (CPI) slowed to 8.5 percent year-over-year in July, vs. 9.1 percent in June. In month-over-month terms, this topline inflation metric was flat. While a steep decline in energy prices was a major factor in this month’s reading, progress was also seen in some other aspects of pricing. Indeed, core inflation rose by just 0.3 percent from the month prior – the smallest uptick since March. While these readings support our view that inflationary pressures may have peaked in Q2 much work remains to be done to remedy elevated inflation. While the next Fed meeting will not occur until late September, we 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

• These July readings are consistent with our expectation that consumer prices would probably peak in Q2 2022, but we maintain that high inflation will remain an issue throughout 2022 and 2023. The incremental progress seen last month was largely due to falling energy prices, but declines in airline fares, used cars and trucks, communication and apparel were also helpful. Additionally, price gains slowed in some key categories, including shelter. However, food prices rose rapidly. While this mixed progress is welcome, some underlying drivers of inflation – such as tight labor markets and rapidly rising wages – will continue to keep inflation well above the Fed’s two-percent target for the foreseeable future. Much work remains to be done.
• Given the current inflationary environment, we expect the Fed will hike 75bp 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 and expenditure deflator, will likely remain notably above the 2 percent target (we forecast 2.7 year-on-year) by the end of 2023.
• 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 coming year and will likely trigger a US recession. Anemic growth and elevated inflation before and after this recession will exhibit stagflationary characteristics.  

July Inflation Highlights

Headline CPI eased somewhat in July, but remains near the 40-year high. The gauge was flat in month-over-month terms, following a 1.3 percent increase in June. On a year-on-year basis, headline inflation fell to 8.5 percent from 9.1 percent the month prior. The moderation was primarily associated with energy prices, which fell 4.6 percent from the previous month with the gasoline index falling 7.7 percent. However, food prices continued to rise – with the food index increasing 1.1 percent from the previous month. Shelter prices, which are heavily weighted in the CPI, rose 0.5 percent month-over-month, vs. rising 0.6 percent in June.

Core CPI also rose for the month, but at a slower rate. The core index, which is total CPI less volatile food and energy prices, rose by 0.3 percent month-over-month in July, vs. 0.7 in June, 0.6 percent in May, and 0.6 in April. However, in year-over-year terms core CPI was flat at 5.9 percent. The slowing in the monthly reading is encouraging and implies that inflationary pressures in the broader economy may be cooling.