U.S. consumer prices increased modestly in August, continuing a trend of slowing inflation that has brought the annual rate to its lowest level since February 2021. According to the latest data from the Bureau of Labor Statistics, the Consumer Price Index (CPI) rose by 0.2% for the month, in line with expectations, and the annual inflation rate eased to 2.5%, down from 2.9% in July. This marks a significant retreat from the inflation peak of mid-2022 when the rate surged to 9%.
The moderation in inflation comes just a week before the Federal Reserve's critical policy meeting, where the central bank is widely expected to approve a quarter percentage point (0.25%) cut in interest rates. Traders in the federal funds futures market are currently pricing in an 85% chance of the Fed implementing this rate reduction, reflecting the market's anticipation of a move aimed at supporting the economy amid signs of a broader slowdown.
While the headline inflation rate shows promising signs of easing, the core CPI, which excludes the volatile food and energy sectors, increased by 0.3% in August, slightly above the 0.2% forecast. On a year-over-year basis, core inflation held steady at 3.2%, highlighting ongoing price pressures in certain areas of the economy.
Housing costs continue to be a significant driver of inflation, with the shelter index-comprising about one-third of the total CPI-rising by 0.5% in August and 5.2% over the past year. This increase in housing-related costs was a primary factor in the overall inflation uptick, even as other categories such as energy and food saw more moderate price changes.
Energy prices, which had spiked dramatically in the previous year, contributed to the cooling inflation figures. The energy index fell by 0.8% in August, with gasoline prices dropping by 0.6% for the month and 10.3% compared to a year ago. Additionally, food prices edged up by just 0.1% in August, further helping to restrain the overall inflation rate.
Despite the positive signs of inflation cooling, market reactions to the report were mixed. Stock market futures dipped slightly following the data release, while Treasury yields saw an uptick. The nuanced response reflects ongoing concerns about the economic outlook, particularly as the Federal Reserve weighs its next steps.
"This isn't the CPI report the market wanted to see," said Seema Shah, chief global strategist at Principal Asset Management. "With core inflation coming in higher than expected, the Fed's path to a 50 basis point cut has become more complicated. The hawks on the committee will likely seize on today's CPI report as evidence that the last mile of inflation needs to be handled with care and caution."
The Federal Reserve has been increasingly focused on the labor market in recent months, as job creation has slowed significantly since April. Central bankers are now balancing the dual challenges of managing inflation while preventing a broader economic downturn. The unemployment rate has remained relatively low, but the pace of job growth has halved compared to earlier in the year, adding to concerns about the potential for a recession.
In addition to the expected rate cut next week, markets are also anticipating further rate reductions in the coming months. Treasury yields, particularly for 2- and 10-year bonds, are at their lowest levels in over a year, reflecting expectations of a continued easing cycle. The recent reversal of the inverted yield curve, a recession indicator, also suggests that markets are bracing for both rate cuts and a possible economic slowdown.
While the latest CPI report confirms that inflation is on a downward trajectory, it also underscores that price stability remains a work in progress. "Although inflation has eased, it does not mean that the prices of things that people buy have actually fallen," noted Lisa Sturtevant, chief economist at Bright MLS. "It just means that prices are not increasing as fast. In fact, U.S. consumers now are paying more than 20% more for goods and services than they were before the pandemic."
