Inflation eased slightly in July, according to the Bureau of Labor Statistics (BLS). The Consumer Price Index (CPI) rose 0.2 percent last month, down from 0.3 percent in June. Core inflation rose 0.3 percent in July, up from 0.2 percent in June. On a year-over-year basis, headline inflation held steady at 2.7 percent, while core inflation climbed to 3.1 percent from 2.9 percent.
The CPI is a weighted average of many goods and services, so breaking it down by category helps explain July’s results. For example, shelter — which accounts for about one-third of the index — rose 0.2 percent and was, according to the BLS, “the primary factor in the all-items monthly increase.” Food prices were flat overall, with a 0.3 percent rise in food away from home offset by a 0.1 percent decline in food at home. Energy prices fell 1.1 percent, driven by a 2.2 percent drop in gasoline.
The slowdown in headline CPI reflected falling energy prices and flat food costs. Core CPI moved in the opposite direction as several categories saw faster price gains, including medical care services, transportation services, and used cars and trucks. In short, categories excluded from core inflation pulled the overall index down, while many within the core pushed it up.
Among core categories, prices rose 0.3 percent in July. Medical care services and transportation services posted the largest increase, up 0.8 percent, followed by used cars and trucks, which rose 0.5 percent. Prices increased for airline fares, recreation, and household furnishings and operations, while lodging away from home and communication services declined.
Given concerns that tariffs could raise consumer prices, a 12-month average may obscure their effect. A better gauge is the recent three-month trend: inflation averaged 0.19 percent per month in May (0.08 percent), June (0.3 percent), and July (0.2 percent), which is equivalent to a 2.29 percent annual rate. That is well below the year-over-year figure of 2.7 percent.
Recent core CPI data tell a similar story. Core prices rose 0.13 percent in May, 0.23 percent in June, and 0.32 percent in July — an average monthly gain of 0.23 percent, which is equivalent to a 2.75 percent annual rate. That’s lower than the year-over-year core figure of 3.1 percent, meaning core inflation has cooled in recent months compared to its year-over-year pace, as well.
The slowdown in inflation, combined with sharp downward revisions to job growth, suggests the Fed’s policy is likely too tight. Over the past three months, both headline and core inflation have been running close to the Fed’s 2 percent target, while the labor market is losing momentum. Keeping the federal funds rate at its current level risks slowing the economy more than necessary. With real (inflation-adjusted) interest rates rising as inflation falls, the Fed should be thinking about cutting its federal funds rate target soon to prevent an avoidable downturn.
Although the Fed officially targets the personal consumption expenditures price index (PCEPI), CPI data provide timely and relevant information for policymakers. The two measures generally track each other closely, though CPI tends to overstate inflation relative to the PCEPI. That makes the latest CPI readings a useful — if slightly higher — signal of where underlying inflation is headed.
With inflation easing and the labor market cooling, the risks of keeping policy too tight are mounting. The CME Group now puts the implied odds of a September rate cut at 92.2 percent, reflecting growing expectations in the fed funds futures market that the Fed will respond to the softer data.
The Fed was slow to act when inflation first accelerated. It should avoid making the opposite mistake now. Waiting too long to cut could mean falling behind the curve again — this time, by letting policy become overly restrictive and pushing the economy into a preventable recession.
