The inflation report may show a moderation in the CPI as gas and travel costs fall

A customer buys eggs at a Kroger grocery store on August 15, 2022 in Houston, Texas.

Brandon Bell | Getty Images

Inflation is still hot, but is expected to have moderated in August as gasoline prices fell, supply chains improved and the cost of travel fell.

The consumer price index is released on Tuesday at 8:30 a.m. ET, and that report could be a little choppy as headline inflation is expected to decline while core inflation, excluding energy and food, should rise. The report is also key as it is expected to influence the Federal Reserve’s decision on how much to raise interest rates next week – and more importantly in the longer term.

The all-items CPI is forecast to have actually fallen 0.1% month-on-month in August, after a flat reading in July, according to Dow Jones. On an annual basis, headline CPI would then run at a pace of 8%, up from 8.5% in July.

But excluding gasoline, core CPI is expected to rise 0.3%, the same as July. On a year-over-year basis, that would make for a 6% gain, even hotter than the 5.9% gain in July.

For the Federal Reserve, the report is widely expected to confirm that it should continue its fight against inflation with an interest rate hike next week of 0.75 percentage points, the third in a row. If inflation data is weaker than expected, some economists say there’s an outside chance the Fed could hike by just half a percent.

“If anything, the risk is that it could get a little weaker,” said Aneta Markowska, chief economist at Jefferies. “I have energy commodities down 10.2%. That should be down half a percent. I think the core will be more important.”

Viewing prices at the pump

Gasoline prices are the biggest driver of the energy decline. Since peaking at $5.01 in mid-June, the national average for unleaded gas has fallen throughout the summer, to an average of $3.71 a gallon on Monday, according to AAA.

Markowska expects headline CPI to fall by 0.2%, but sees an underlying increase of 0.3%. Housing is one area expected to grow, while used car prices are expected to fall.

“I think we’re going to see a repeat in terms of airfares and hotel prices. They dragged down the core CPI last month. It looks like airfares are going to come down by 8%,” Markowska said. “They were up 40% from March to May. We’re just smoothing out some of that.”

Economists say the core effects of comparing the number with last year are behind the rise in August’s core inflation.

“Due to base effects, annual core inflation is likely to accelerate in the next two reports, which would make for unpleasant headlines for the Fed,” wrote Blerina Uruci, chief US economist at T. Rowe Price. She said it shouldn’t matter to Fed officials as they will be more focused on momentum and watch the annual quarterly and six-month pace.

But they are also sensitive to how it will look to the public and Congress. All the more reason to keep a sharp focus,” she added.

Strategists say the Fed’s Sept. 21 rate decision could be influenced by the August CPI report, but the details within that report may be more important to what they say about the longer-term outlook. That could help shape expectations for the Fed’s final rate hike when it stops hiking.

Looking to the end of the game

Market expectations for the Fed’s terminal rate have been higher and in the futures market, the view is that it will reach 4% early next year. Markowska expects it could reach 4% to 4.25% in January.

“This is where we start to look at whether there is a shift in the underlying patterns, where the Fed can taper or not,” said Diane Swonk, chief economist at KPMG. She expects the Fed to raise the Fed funds target by 75 basis points next week. That would bring the Fed funds target range to 3% to 3.25%. One basis point is 0.01 percentage point.

“That gets them into tight policy. Then it’s a matter of how tight they want to go,” Swonk said.

This is a key question for the markets, as some professionals expect the Fed to stop by the end of the year. Others expect a pause early next year, and some investors believe the Fed will begin cutting interest rates in the second half of next year.

Fed officials, led by Chairman Jerome Powell, have stressed that the Fed will raise rates and keep them there. However, the market is still betting that the Fed will not be as tough as it is being talked about.

“I don’t think this report changes much for the Fed. I think the problem for the Fed is even though inflation is slowing, growth momentum is picking up in part because energy prices are lower,” Markowska said. “This is increasing purchasing power.”

She said consumers appear to be diverting dollars that would have gone toward fueling their cars toward other goods and services. That could keep the economy hotter than the Fed wants, and it now expects third-quarter growth of 3% or more.

“This is an above-trend increase at a time when the Fed should be creating a below-trend increase,” Markowska said.

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