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Weakest monthly core CPI reading in the US since 2021 builds case for Fed rate cuts
The emergence of the inflation dragon over 2021-22 and the subsequent central bank rate hikes to contain it have dominated the financial market landscape for the past few years. The first quarter of 2024 was no exception, with the US economy marred by a surprise pick-up in inflation momentum. This clearly delayed plans of policy easing by the US Federal Reserve over the first half of 2024.
However, recent inflation outturns emanating from the US have been far more encouraging. The latest CPI reading for June surprised to the downside, with headline prices dropping 0.1% over the month. This saw the year-ended inflation rate fall from 3.3% to 3.0%, the equal lowest outturn seen since March 2021.
While lower gasoline prices were partly behind the fall in June, the far more promising aspect were signs of weaker underlying inflationary pressures. Excluding food and energy prices, the core CPI was surprisingly tame, rising just 0.1% over the month. This was the softest monthly outturn since January 2021. In year-ended terms, the core CPI inflation rate eased from 3.4% to 3.3% in June, again the lowest outturn since 2021.
Importantly, the details of the CPI report revealed a broad-based moderation in underlying price pressures. Core goods prices continued to fall over the month, largely due to a moderation in auto prices, while core services price inflation excluding housing rent also fell following sharp gains earlier in the year. Housing rents (both primary and owner-occupier) are also finally showing signs of a meaningful moderation in growth, rising just 0.3% over the month, down from 0.4% in each of the prior three months. The long-foreshadowed moderation in housing rents is important, as they tend to be a stickier component of the CPI, and incoming data on new leases suggests this more moderate pace of rental growth should continue beyond June.
Looking through the details, there are some reasons to suspect that the moderation of inflation evident in June may modestly overstate the underlying trend in prices. In particular, outsized falls in airfares (-5%) and lodging away from home (-2%) are unlikely to be repeated. Nonetheless, even excluding these factors there is clear evidence of diminishing inflation pressures in the US over recent months.
To highlight the recent improvement in inflation momentum, one only needs to look at the annualised rate of core CPI inflation over the past three-month period that has slowed to just 2.1% in June, down from an elevated 4.5% seen in the prior three-month period to March.
The incoming inflation data will no doubt be welcomed by the US Federal Reserve. In his semi-annual testimony to Congress this week, Fed Chair Powell noted “…the most recent inflation readings, however, have shown some modest further progress, and more good data would strengthen our confidence that inflation is moving sustainably toward 2 percent.” The subsequently released CPI report provided the ‘more good’ data that the Fed was looking for.
While Powell’s testimony was very similar to previous messaging, there was a minor change in emphasis around the balance of risks with increased focus on the softening labour market and economic data. In particular, Chair Powell noted that “We know that reducing policy restraint too soon or too much could stall or even reverse the progress we have seen on inflation. At the same time, in light of the progress made both in lowering inflation and in cooling the labor market over the past two years, elevated inflation is not the only risk we face. Reducing policy restraint too late or too little could unduly weaken economic activity and employment.”
Given our expectations of an ongoing moderation in inflationary pressures and further softening in the labour market, we continue to expect two rate cuts by the US Federal Reserve in 2024, with the first commencing in September. Financial markets have adopted a similar view, pricing in a rate cut in September and almost 2½ cuts by December. Although policy will need to remain restrictive for some time to ensure the inflation dragon is well and truly slayed, the progress seen to date should allow the Fed to move towards lowering rates in September.