U.S. Core Inflation Increases Due to Metals Costs, Tariffs

U.S. consumer prices rose more than expected in July, reinforcing our view that the Fed will continue its gradual pace of interest rate hikes, at least for now.

July’s U.S. CPI (Consumer Price Index) report showed core inflation accelerated to a 2.4% annual rate, up from 2.3% in June, as businesses may have started to pass on rising costs of industrial metals and fuels. Price hikes ahead of potential tariffs could have also contributed to the rise in core CPI. However, prices of consumer services, including shelter, which tend to be more sensitive to the domestic business cycle, continued to trend sideways.

Looking ahead, the extent to which inflation from higher input costs continues to accelerate will depend in part on the price sensitivity of consumers and whether trade tensions between the U.S. and its trading partners escalate further. For now, we continue to forecast core CPI inflation will end the year at around 2.3%, but would note that the Trump administration’s trade policies present a near-term upside risk to our inflation forecast.

Overall, today’s print doesn’t change our view that domestic inflationary pressures remain manageable and one to two more interest rates hikes are likely in 2018. The Fed should be more tolerant of temporary bouts of inflation due to rising trade tensions, focusing instead on mitigating the negative effects on final domestic demand.