US core inflation accelerates, reducing chances of larger Fed rate reduction

In a surprise move, underlying U.S. inflation unexpectedly picked up in August, driven by higher prices for housing and travel. This unexpected increase has dampened the chances of an outsize U.S. Federal Reserve interest-rate cut next week.

The Core Consumer Price Index: A Better Indicator of Underlying Inflation

Economists see the core consumer price index (CPI) as a better indicator of underlying inflation than the overall CPI. This measure excludes food and energy costs, which can be volatile. The latest figures show that the core CPI increased 0.3% from July, marking the most significant increase in four months. On an annual basis, the core CPI rose 3.2%, exceeding expectations.

Shelter Prices: A Key Driver of Inflation

The advance in the core CPI was driven by shelter prices, which climbed 0.5% in August, the most since January. This marked the second consecutive month of acceleration, defying widespread expectations for a downshift. Owners’ equivalent rent (OER), a subset of shelter and the largest individual component of the CPI, rose at a similar pace.

Service Prices: A Key Area of Focus for Central Bankers

Excluding housing and energy, service prices advanced 0.3%, the most since April. While central bankers have stressed the importance of looking at this metric when assessing the nation’s inflation trajectory, they compute it based on a separate index called the personal consumption expenditures (PCE) price index.

The PCE Measure: A Closer Look

The PCE measure draws from the CPI as well as certain categories within the producer price index. The PPI report, due Thursday, is projected to show a tame pace of wholesale inflation. Central bankers are increasingly paying attention to labor market developments amid emerging cracks in the job market.

A Sustained Decline in Goods Prices

A sustained decline in goods prices over most of the past year has largely provided some relief to consumers. So-called core goods prices, which exclude food and energy commodities, fell 0.2%. The metric has now declined in 14 of the last 15 months.

The Labor Market: A Key Area of Focus for Central Bankers

Central bankers are increasingly paying attention to the labor side of their dual mandate amid emerging cracks in the job market. Hiring over the past three months is at the lowest since mid-2020, while job openings declined and layoffs rose in July.

Real Earnings: A Key Metric for Consumer Spending

A separate report Wednesday that combines the inflation figures with recent wage data showed that real earnings grew 1.3% from a year ago, the most in over a year. This suggests that consumers may continue to drive economic growth despite higher inflation.

In conclusion, the unexpected increase in core U.S. inflation has dampened the chances of an outsize Federal Reserve interest-rate cut next week. However, central bankers remain focused on labor market developments and wage growth, which will continue to inform their policy decisions.