U.S. inflation picking up; Fed rate cut still expected

WASHINGTON (Reuters) - U.S. consumer prices increased broadly in July, but the signs of an acceleration in inflation will likely do little to change market expectations that the Federal Reserve will cut interest rates again next month amid worsening trade tensions.

FILE PHOTO: People shop at Macy's Department store in New York City, U.S., March 11, 2019. REUTERS/Brendan McDermid

The report from the Labor Department on Tuesday, however, lowered the chances that the U.S. central bank would cut rates by half a percentage point at its Sept. 17-18 policy meeting.Financial markets have fully priced in a 25-basis-point reduction following a recent escalation in the bruising trade war between the United States and China, which sparked a stock market sell-off and caused an inversion of the U.S. Treasury yield curve, heightening the risk of a recession.

President Donald Trump announced last month an additional 10% tariff on $300 billion worth of Chinese imports starting Sept. 1. China let its currency, the yuan, slide past the key 7-per-dollar level to its lowest point since the 2008 global financial crisis before trying to stem the decline.

On Tuesday, the Trump administration delayed the imposition of the additional tariff on certain Chinese imports, including technology products and clothing, until mid-December.

Economists said the move still left a cloud over the U.S. economy. Fears about the impact of the trade fight on the economic expansion, the longest in history, prompted the Fed to cut its short-term lending rate by 25 basis points last month for the first time since 2008.

“The recent pickup in inflation won’t deter the Federal Reserve from cutting interest rates in September as the downside risks to the outlook from trade have become more threatening,” said Ryan Sweet, a senior economist at Moody’s Analytics in West Chester, Pennsylvania.

The consumer price index increased 0.3% last month, lifted by gains in the cost of energy products and a range of other goods, the government said. The CPI had edged up 0.1% for two straight months. In the 12 months through July, the CPI increased 1.8% after advancing 1.6% in June.

Economists polled by Reuters had forecast the CPI would accelerate 0.3% in July and rise 1.7% on a year-on-year basis.

Excluding the volatile food and energy components, the CPI gained 0.3% after rising by the same margin in June. It was the first time since early 2001 that the so-called core CPI increased 0.3% for two consecutive months.

The core CPI was boosted by increases in prices for apparel, airline tickets, healthcare and household furnishings. In the 12 months through July, the core CPI climbed 2.2%, the biggest gain in six months, after rising 2.1% in June.

The three-month core inflation rate jumped 2.8%, the most in eight years, supporting the view that weak inflation readings earlier in the year were caused by transitory factors.

The Fed, which has a 2% inflation target, tracks the core personal consumption expenditures (PCE) price index for monetary policy. The core PCE price index rose 1.6 percent on a year-on-year basis in June and has undershot its target this year.

“Weak transitory components that were weighing on inflation are rebounding as expected,” Veronica Clark, an economist at Citigroup in New York.

Stocks on Wall Street rallied on the U.S. pullback from a hardline trade stance toward China. The dollar .DXY strengthened against a basket of currencies, also boosted by the inflation data. U.S. Treasury prices fell.


Inflation has remained moderate despite the White House’s tariffs on Chinese imports as the duties have been largely on capital goods. Economists expect the new tariffs, which would affect mostly consumer goods, will boost inflation, regardless of the delays of duties on laptops, cell phones, video game consoles, certain toys, computer monitors, and certain footwear and clothing items.

Goldman Sachs estimates that tariffs have boosted year-on-year core PCE inflation by 10-15 basis points so far and that the new duties will add another 20 basis points.

“There were some hints in the report that the May round of tariffs may have had some flow-through to today’s number,” said Michael Feroli, an economist at JPMorgan in New York. “Core goods prices were up a firm 0.25%, with large increases in import-dependent categories like information technology commodities and household furnishings and supplies.”

In July, gasoline prices rebounded 2.5% after dropping 3.6% in June. Electricity rose 0.6%. Food prices were unchanged for a second straight month. Food consumed at home slipped 0.1%.

Owners’ equivalent rent of primary residence, which is what a homeowner would pay to rent or receive from renting a home, rose 0.2% in July, the smallest gain since December 2018. Rents had risen by 0.3% for six straight months.

Healthcare costs jumped 0.5%, the most since August 2016, after advancing 0.3% in June. There were increases in prices for hospital services, doctor visits and prescription medication.

Apparel prices rose 0.4% after surging 1.1% in June. Used motor vehicle and truck prices increased 0.9% in July after rebounding 1.6% in the prior month.

Prices for new motor vehicles fell 0.2%. The cost of household furnishings and operations increased 0.4%, rising for a third straight month, reflecting the import duties.

Airline tickets rebounded 2.3%, the largest advance in a year. There were also increases in the costs of motor vehicle insurance, personal care products, tobacco and alcohol.

(GRAPHIC - U.S. inflation interactive graphic:

Reporting by Lucia Mutikani; Editing by Paul Simao