The latest inflation report was slightly better than expected but likely not good enough to stop the Federal Reserve from raising interest rates again at its next meeting.
Inflation slowed to 8.5% for the 12 months ending in July, according to the consumer price index, a signal that price pressures might be peaking. The consensus was that it would tick down to 8.7%, so the reading was welcome news for Fed officials and shows that the central bank’s aggressive rate-hiking cycle is starting to slow inflation.
The Fed has been on its most ambitious tightening cycle in recent history. As inflation has continued at stubbornly high levels, the central bank’s monetary policy has become increasingly hawkish.
After an unprecedented two years of interest rates at near-zero levels, the Fed finally conducted its first hike in March, raising rates by the typical quarter of a percentage point. That was followed by a more urgent increase of half a percentage point, or 50 basis points, in May, although inflation continued to rise.
In June, following a two-day meeting, central bank officials announced that the Fed would increase its interest rate target by a whopping three-quarters of a percentage point. The Fed then conducted another hike of 75 basis points last month, likely opting for that scale of increase because inflation came in hotter than expected in June, punching in at 9.1% as measured by the CPI.
Central bank officials will meet again in September and will undoubtedly conduct another rate hike. Fed officials have signaled that an increase of 50 basis points is likely in the cards, but some think it could be as high as another 75 basis points.
Desmond Lachman, a senior fellow at the American Enterprise Institute, told the Washington Examiner that despite the headline number of 8.5% falling more than anticipated, he doesn’t think it is enough to justify the Fed shifting away from another big rate hike in September.
Lachman pointed out that there are still several important reports that will come before the central bank’s decision, including the August CPI and employment reports.
Core CPI, which strips out volatile food and energy prices, increased by 0.3% in July, slightly more than expected. The figure shows that inflation is still a huge concern for the Fed and for the average consumer. Core inflation is also now at 5.9% annually, three times what the Fed wants to see it running at.
Victor Claar, an economics professor at Florida Gulf Coast University, told the Washington Examiner that he anticipates the Fed’s hawkishness to continue because core CPI was elevated in July despite the headline number tumbling.
“I don’t think they’re going to change course at all here. I think the only possibility is if they were thinking 75 versus 50, now maybe they’re thinking 50 versus 75,” Claar said. “It’s not like inflation rates are falling yet. We’ve just seen one month where, mostly because gas prices went down, they leveled off a little bit.”
Investors are now pegging the odds of a hike of 75 basis points at just over 40% and pricing in about a 60% chance of a hike of 50 basis points, according to CME Group’s FedWatch tool, which calculates the probability using Fed fund futures contract prices. A day before the July inflation report, which came in a bit better than expected, investors were pegging the odds of a hike of 75 basis points at nearly 70%.
Another factor bolstering the likelihood of another big rate hike is the tight labor market, which has consistently defied economists’ projections over the past few months.
The economy once again exceeded consensus estimates and added 528,000 jobs in July. The unemployment rate also unexpectedly fell to 3.5%, matching the ultralow level it was at prior to the pandemic.
The strong jobs report will give the Fed more confidence that the economy can withstand the continued aggressive rate hikes.
Digging further into the July CPI report, the biggest factor causing headline inflation to decline to 8.5% is falling gas prices.
The gasoline index fell 7.7% in July, which offset increases in food and shelter costs. The energy index fell 4.6% on the month but is still up a sky-high 32.9% for the 12 months ending in July. Food prices have increased nearly 11% during that same period, according to the report.
“We’ve had oil prices come down pretty sharply, so international oil prices used to be around about $120 a barrel and we’re now down to $90,” Lachman explained. “What’s been happening is gasoline prices have been coming down steadily — that was one of the big drivers of [the new inflation report].”
Lachman said the new numbers might indicate that inflation has started to peak and is expecting that next month will see another decline in the headline CPI number, noting that gas prices have fallen even further since July. Just one week ago, the average price for a gallon of gas was 15 cents more expensive.
The surging inflation has a very tangible and real-world effect on the average person and has made life much less affordable for consumers. Some of the goods seeing the biggest increases are food products, causing pain at checkout lines across the country.
For instance, egg prices have increased by a mammoth 38% over the past year. If a family of four consumes three cartons of eggs per week and a 12-egg carton was $2.48 a year ago, that family would have spent $387 annually on the breakfast staple. That same family is now spending $624 per year on the same eggs, an added $237 expense.
That family of four is also now paying $4.40 on average for a gallon of whole milk, more than half the hourly federal minimum wage, according to the Department of Agriculture. That is a dramatic increase from last year when a gallon of whole milk went for about $3.69 on average. If the family were to buy two gallons of milk per week, that translates to $73.84 in extra annual spending.
While gas prices have dropped lower from their zenith of above $5 per gallon, a gallon of gas is now running consumers a bit over $4, according to a national average by AAA. Last year, that same gallon cost $3.19.
If that family owns a Chrysler Pacifica minivan and fills up once per week, its weekly gas expenses are now $76.19. Over the course of a year, the family would end up spending about $830 more on gas than it did with last year’s prices.
Some in the Biden administration, such as White House chief of staff Ron Klain, have touted wage growth in the face of towering inflation. While wages did increase in July more than expected, they have not kept pace with the higher prices. Real average hourly earnings are still down 3% from a year ago.
Another question is whether the economy is in a recession or will tumble into one. There have been two quarters of negative GDP growth, which has traditionally been a recessionary indicator, although the strong jobs market is running contradictory to the notion.
“As the rest of 2022 unfolds, I think we’re going to realize that we are in a recession — it’s just a very different sort of recession than we’ve ever been in before, much like the stagflation of the 1970s and early 80s was a recession like we’ve never seen before,” said Claar, the Florida Gulf Coast University economics professor.
