July U.S. CPI Offers Some Relief, But Fed Also Watches Other Inflation Indicators

As expected, U.S. inflation – both headline and core – moderated in July, according to the latest Consumer Price Index (CPI) data. Assuming global food and energy commodity prices continue to ease, June likely marked the peak in the year-over-year (y/y) rate of headline inflation. However, the y/y rate of core inflation will likely reaccelerate in August, and may not peak until September.

The categories that drove the July weakness in core – airfares and hotels – tend to be more volatile, whereas the stickier components – rents and owners’ equivalent rents (OER) – remained firm in July.

The CPI report, and the recent moderation in short-term inflation expectations, are surely a relief for Fed officials, but with inflation still expected to moderate to a pace that is above their 2% long-run PCE (personal consumption expenditures) target, the July CPI isn’t likely to change the near-term trajectory for monetary policy. Indeed, restrictive policy still appears appropriate, meaning more rate hikes are still to come.

Prices drop for energy, hotels, airfares, used cars

The July report showed U.S. core CPI increased 0.3% month-over-month (m/m) – softer than consensus expectations of 0.5% m/m. The moderation was almost entirely due to price drops across hotels, airfares, and used cars. Indeed, airfares fell −7.8% m/m as lower jet fuel prices passed through to consumers. Hotel prices, after surging well beyond pandemic levels earlier this year, appear to be normalizing (they fell −3.3% m/m) as the initial surge in reopening demand fades and consumers struggle with high prices. We expect airfares will remain weak, but hotel prices could post small gains in coming months.

New car prices continued to climb (+0.6% m/m) as inventories remain near record lows and production data indicate disruption continued through the spring and early summer. Meanwhile, used car prices fell −0.4% m/m and are likely to drop again next month before reaccelerating somewhat in the fall. Rental car companies aren’t expected to sell into the used car market as aggressively as usual in the coming months due to the continued dearth of new cars. Nevertheless, over time we expect used car prices to retrace some of their exponential price gains since the pandemic, as higher interest rates, slower migration out of city centers, and a normalization in new vehicle inventories moderates demand for used vehicles.