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August 13, 2019 Blog 2 min read
Despite slowing growth, inflation picked up unexpectedly last month, complicating the Fed’s policy options and muddying the rate outlook.

8-13-19 CPI Chart

The consumer price index (CPI) rose 0.3% in July, in line with consensus economist expectations. A surge in energy prices offset flat food costs for the second consecutive month, pushing the core index also higher by 0.3%. Over the past year, headline CPI increased 1.8% through July while core CPI came in at 2.2%, matching its highest level since January.

The acceleration in core inflation in particular was unexpected, and will undoubtedly weigh on the minds of investors trying to discern the Fed’s next steps.

Of particular note were service-sector costs, which continue to rise at an accelerated pace, led by rising shelter and medical costs, both of which rose by more than 3% over the past year.

Also of note was the increase in energy costs – the first in three months. Even so, energy costs are still down 2.0% in the last year, which has helped to keep a lid on headline inflation measures.

The Fed will take note of this report as policymakers evaluate the need for further rate cuts to provide some cushion in an effort to blunt the effects of and risks presented by slowing growth. Although the central bank’s preferred measure of price levels remains below its 2% target, the modest uptick in inflation in recent months will make it harder to justify additional cuts.

The U.S. labor market remains tight by many measures, but wage growth has been surprisingly tame. With unemployment this low, inflation closer to 4% has been typical, but it has yet to sniff anything close to that in the current cycle.

More broadly, renewed trade concerns have weighed on sentiment, and the looming threat of additional tariffs on Chinese goods has put into question the growth trajectory in the second half of the year. Investors have been banking on the Fed to cut rates in response, with most expecting the central bank to trim by at least another half percent by the end of the year. That bet may yet come back to bite investors in the backside if inflation gauges continue to edge higher.

Even so, today’s report on inflation muddies the outlook, but may not derail the process. One report or data point alone won’t drive the Fed’s decision. Still, the September inflation report scheduled to be released shortly before the Fed’s next policy meeting just became much more important.

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