August’s consumer price index (CPI) report signalled inflation is starting to cool after surging this summer as America’s economy reopens. Excluding food and energy costs, consumer prices only rose by 0.1% last month, the smallest gain since February. Thus, core inflation fell from 4.3% in July to 4.0% YoY in August.
The data was weaker than expected as prices that had jumped as the US reopens decreased in August with supply starting to catch up with demand. For example, used car prices fell 1.5%, lodging costs declined 2.9% and airfares plunged 9.1% last month.
Core inflation still remains well above the Federal Reserve’s 2% target as the chart shows. But having been as high as 4.5% in June, the latest data for August will give officials confidence that this year’s increases in inflation as the US economy reopens will largely be transitory and thus not require early interest rate hikes to push inflation back to the Fed’s 2% goal.
The Federal Open Market Committee (FOMC) meets next week on September 21-22. Members are likely to welcome August’s CPI data but will be wary still of the risks of inflation staying above target if the Fed doesn’t start soon tapering its quantitative easing as the US economy recovers.
First, August’s CPI report showed the economy still continues to suffer from shortages pushing prices up for items dependent on commodities.
Source: Bank of Singapore, Bloomberg.
New car prices increased by 1.2% last month owing to the worldwide shortage of semiconductors. Similarly, household furnishings and supplies also rose by 1.2% in August owing to higher commodity prices. Thus, mismatches in supply and demand as the US economy reopens are still likely to keep inflation elevated for months above the Fed’s 2% target before activity returns to more normal pre-pandemic levels.
Second, more persistent sources of inflation including rents are turning up as the US housing market rebounds strongly. Sheltering costs account for a third of US consumer prices and, as the chart shows, are trending higher. Similarly, medical care costs also rose by 0.3% last month.
Thus, we expect the Fed will keep its quantitative easing at USD120 billion a month of bond buying when the FOMC meets this month. But officials will signal that tapering is still likely to start this year. We think the Fed will announce in November that it will start reducing its asset purchases from December onwards to reduce the risks of the US recovery overheating. This will still be a gradual exit from quantitative easing only so risk assets shouldn’t suffer a taper tantrum.
Last, the Fed will also publish new forecasts at this month’s meeting. August’s cooler CPI data makes it likely the median or average FOMC forecast will still be for interest rate rises to only begin in 2023 - to the benefit of risk assets - rather than earlier in 2022 once tapering has finished.Disclaimer applicable to recommendation
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