Inflation report could show CPI moderating with gasoline, travel costs falling

A customer buys eggs at a Kroger grocery store on August 15, 2022 in Houston, Texas.

Brandon Bell | Getty Images

Inflation is still scorching, but is expected to have moderated in August as gasoline prices have fallen, supply chains have improved and the cost of travel has fallen.

The Consumer Price Index will be out Tuesday at 8:30 a.m. ET, and the report could get a little confusing as headline inflation is expected to decline while core inflation, excluding energy and food, is expected to rise. The report is also key because it should influence the Federal Reserve’s decision on how much to raise interest rates next week — and more importantly, in the long run.

The CPI for all items is actually expected to have fallen 0.1% month-over-month in August, after a flat reading in July, according to Dow Jones. On an annual basis, the overall CPI should then evolve at a rate of 8%, against 8.5% in July.

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But excluding gasoline, core CPI is expected to rise 0.3%, as in July. On an annual basis, this would represent a 6% increase, even higher than the 5.9% gain recorded that month.

For the Fed, the report is expected to confirm that it must continue its fight against inflation with an interest rate hike next week of 0.75 percentage points, the third of this size in a row. If the inflation data is weaker than expected, some economists say there’s an outside chance the Fed could hike just 0.5%.

“If anything, the risk is that it could get a little weaker,” said Aneta Markowska, chief economist at Jefferies. “I have energy holdings down 10.2%. That should drop half a percent. I think the core is going to be more important.”

Look at the prices at the pump

Gasoline prices are the main driver of the energy decline. Since peaking at $5.01 in mid-June, the national unleaded gasoline average has been falling all summer, reaching an average of $3.71 per gallon on Monday, according to AAA.

Markowska expects the headline CPI to fall 0.2%, but sees an increase of 0.3%. Housing is an area that is expected to increase, while used car prices are expected to fall.

“I think we’re going to see a repeat in terms of air fares and hotel prices. They’ve driven core CPI down last month. It looks like air fares will be down 8%,” Markowska said. . “They’re up 40% from March to May. We’re just cutting some of it.”

Economists say base effects from the number’s comparison with a year ago were behind the jump in core inflation in August.

“Because of base effects, annual core inflation is likely to pick up in the next couple of reports, which would make headlines uncomfortable for the Fed,” wrote Blerina Uruci, chief economist at T. Rowe. Price. She said that shouldn’t matter to central bank officials as they will focus more on momentum and watch the three- and six-month annualized pace.

But they are also sensitive to how it will present to the public and to Congress. All the more reason to maintain a warmongering focus,” she added.

Strategists say the Fed’s Sept. 21 rate decision could be affected by the August CPI report, but the details in that report may be more important in terms of what they say about longer term outlook. This could help shape expectations for the Fed’s final or terminal rate when it stops climbing.

Looking towards the endgame

Market expectations for the Fed’s terminal rate have risen slightly, and in the futures market it is expected to hit 4% early next year. Markowska expects it could reach 4% to 4.25% in January.

“This is where we start looking at whether there’s a change in the basic patterns, where the Fed can slow down or not,” said Diane Swonk, chief economist at KPMG. She expects policymakers to raise the federal funds target range by 75 basis points next week. That would bring the federal funds target range to 3% to 3.25%. One basis point is 0.01 percentage point.

“It puts them in a strict policy. Then it comes down to how far they want to go,” Swonk said.

This is a key question for the markets, as some pros expect the Fed to take a break by the end of the year. Others expect a break early next year, and some investors think the central bank will start cutting interest rates in the second half of 2023.

Fed officials, led by Chairman Jerome Powell, have pointed out that they will raise the rates and keep them. Yet the market is still betting that policy makers won’t be as tough as their talk.

“I don’t think this report changes much for the Fed. I think the problem for the Fed is that while inflation is slowing, growth momentum is picking up partly because energy prices are lower,” Markowska said. “It increases purchasing power.”

She said consumers seem to be diverting money that was used to fuel their cars to other goods and services. That could keep the economy warmer than the Fed wants, and it now expects growth of 3% or more in the third quarter.

“This is above-trend growth at a time when the Fed needs to design below-trend growth,” Markowska said.

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