Inflation slowed down on an annual basis in August, with the Consumer Price Index rising by 2.5 percent compared to a year ago. This is a noticeable drop from July’s 2.9 percent and a significant decline from the peak of 9.1 percent seen in 2022.
Next week, Federal Reserve officials are expected to lower interest rates for the first time in over four years. This latest inflation report, the lowest in more than three years, is one of the final key economic indicators ahead of their decision.
The data further demonstrates that inflation is moderating after the sharp increases of 2021 and 2022. As a result, the Fed may now shift from its strategy of raising interest rates over the past two years to combat rising prices.
Investors are anticipating that the Fed will reduce interest rates at their upcoming policy meeting on Tuesday and Wednesday. The general expectation is for a quarter-point cut from the current 5.33 percent rate, although some see a larger half-point reduction as a possibility.
Key Points to Note:
- Core inflation trends: Excluding volatile food and energy prices, core inflation in August was 3.2 percent, aligning with forecasts from economists.
- Monthly changes: Overall inflation was modest on a monthly basis, but core inflation increased by 0.3 percent, a bit more than anticipated.
- Focus on housing: The slight uptick in core inflation was driven in part by rising housing costs, specifically the cost of renting owned homes. Economists are watching this closely as it was expected to slow down. Persistent increases in this area could complicate efforts to fully control inflation.
- Fed’s approach: Raising interest rates helps cool down the economy by making borrowing more expensive, which reduces demand and limits businesses’ ability to raise prices. Now, Fed officials need to ensure they don’t tighten too much, as high rates for an extended period could lead to higher unemployment or even a recession.
- September outlook: The increase in core inflation likely supports a smaller, quarter-point rate cut in September rather than a half-point reduction. Investors were already predicting that a smaller move was more probable.
- Looking ahead: Beyond September, the pace at which the Fed adjusts rates in the coming months will be more significant. Fresh quarterly economic forecasts, to be released next week, will provide insight into the Fed’s long-term plans for interest rates.
- Political context: As inflation normalizes, consumers are starting to feel some relief, with wage growth outpacing price increases for over a year. This is positive news for the Biden administration, which has struggled to gain recognition for its economic achievements amid the earlier inflation surge.