Inflation slows to three-year low, clearing way for Fed rate cut

Dive Brief:

The consumer price index rose last month at a 2.5% annual rate, easing from 2.9% in July to the slowest pace in more than three years, the Labor Department said Wednesday, all but ensuring that the Federal Reserve will trim borrowing costs next week.
Shelter costs spurred inflation more than any other factor in August, increasing 0.5%. Energy prices dipped 0.8% last month, led by a 1.9% decline in fuel prices, while energy service prices fell 0.9%. So-called core CPI, which excludes volatile food and energy prices, edged up 0.3% to a 3.2% annual rate, slightly above the July pace.
“The combination of softer demand for goods and services due to increased price sensitivity, reduced markups, moderating wage growth and moderating rent inflation will continue to provide a healthy disinflationary impulse heading into 2025,” EY Senior Economist Lydia Boussour said in an email. EY forecasts three, quarter-point rate cuts during the remainder of 2024 and reductions totalling 1.25 percentage points next year.

Dive Insight:

The persistence of shelter cost inflation, which rose 5.2% in the 12 months through August, prompted traders in interest rate futures to retreat from predictions that policymakers on Sept. 18 will cut the federal funds rate by as much as a half percentage point.

Traders Wednesday saw just 15% odds that the Fed will cut the main rate by a half point next week compared with a 34% probability on Tuesday, according to the CME FedWatch Tool. They see 85% odds of a quarter-point reduction from the current range between 5.25% and 5.5%.

“While the disinflation trend remains intact, the bumpiness in services prices will likely provide ammunition for the less dovish policymakers to push for a methodical approach to reducing rates,” Boussour said.

Since mid-2023 inflation has zig-zagged down toward the Fed’s 2% target. Along with shelter prices, the cost of transportation services and apparel also increased last month, rising 0.9% and 0.3%, respectively.

“It is too early to declare victory on inflation,” Bank of America economists said in a report Wednesday, noting persistent inflation in owner-equivalent rent.

“We think that the Fed cannot take its eye off the ball on inflation,” the Bank of America economist said. “Therefore, a methodical cutting cycle (25 basis points per meeting) seems to be the most prudent path for now.”

Robust increases in wages will likely fuel some price pressure, Conference Board Chief Economist Dana Peterson said Wednesday during a webcast.

Companies plan to raise their salary budgets by 3.9% next year, a near-record increase prompted by a declining supply of workers, the Conference Board said Monday.

The rise in salary budgets, although lagging the 4.4% boost in 2023, will exceed the 3.8% gain this year, the Conference Board said, reporting on a survey of 300 “compensation leaders” on plans for base pay.

“We’re still seeing big increases in wages and benefits that are going to pass through,” Peterson said, predicting that inflation will not fall to the Fed’s target until mid-2025.

“There’s some risk that we get there sooner,” she said. “That’s great, but the Fed will need to keep it there.”

Consumer expectations for inflation, a trend closely followed by policymakers, remained largely steady last month.

Median inflation expectations for the one- and five-year time horizons were unchanged at 3% and 2.8%, respectively, according to the New York Fed.

Over a three-year horizon, consumers expect 2.5% inflation, 0.2 percentage point higher than July, the New York Fed said Monday, describing survey results.