August CPI: Probably a 25 bps rate cut next week

Summary

August's inflation data probably cement a 25 bps, rather than a 50 bps, reduction in the federal funds rate at next week's FOMC meeting in our view. The 0.2% increase in headline CPI was in line with expectations, while the 0.3% increase in core CPI was slightly higher than consensus forecasts.

Another month of tepid food inflation and falling energy prices kept headline inflation in check. Excluding food and energy, the deflation in core goods remained in effect, led by a 1.0% drop in prices for used autos. A larger-than-expected drop in prices for core goods was more than offset by faster-than-expected services inflation. A bounce back in travel-services prices such as lodging away from home and airfares ended a run of unusually soft readings for these categories. Primary shelter inflation also came in high relative to our expectations and at odds with leading indicators from private sector data sources. Overall, we see the lingering split between goods and services inflation as a sign that the unwinding of pandemic-era effects on prices is taking somewhat longer, rather than as an indication disinflation is running out of steam.

On balance, today's data suggest that a 25 bps rate cut is more likely than 50 bps next week, but we would not be completely shocked if the FOMC elected to move by 50 bps. Furthermore, starting with a 25 bps move does not rule out a pickup in the pace of policy easing at future meetings. The ongoing deterioration in the labor market has become an increasing focus for the FOMC, and inflation is slowly but surely returning to 2% on trend. The core CPI has increased at a 2.1% annualized pace over the past three months, a slow enough pace that 50 bps rate cuts at future meetings remain squarely on the table if the labor market data spur faster action. Regardless, all signs point to additional rate cuts beyond next week in our view.

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