CPI will not hinder the Fed from cutting interest rates! Unless there are significant unexpected developments in these sub-items

The U.S. August CPI inflation data will be released on Wednesday night at 8:30 pm. Analysts believe that this is the last important economic data before the Fed's September meeting. Unless a major unexpected event occurs, there is no factor to prevent the Fed from cutting interest rates, and it may even cut rates by a significant margin.

Both overall and core CPI rose by 0.2% in July. Due to a significant drop in gasoline prices, the overall CPI in August may show a lower month-on-month increase, possibly even rounding to zero. It is expected that food prices will also see inflation close to zero again. Meanwhile, the core CPI may record another 0.2% increase month-on-month. The core CPI in July was affected by a significant drop in used car prices and a decrease in medical service prices. However, although used car prices may continue to decline, the 0.3% decrease in the medical service price index is an anomaly and is unlikely to repeat in the future.

Dean Baker, Senior Economist at the Center for Economic and Policy Research (CEPR), believes that the August CPI report will once again demonstrate more progress by the Fed in reducing inflation. The most critical factors are two rent indices, which account for over one-third of the CPI weight. In this case, we can determine the overall direction of inflation, just not sure to what extent the inflation rate of these indices will slow down. It is worth noting that excluding the rent indices, the annualized inflation rate of CPI will also be below 2.0%.

Here is his analysis of each sub-item of the CPI.

Food prices will remain stable

After rapid increases in 2021 and 2022, food price inflation slowed last year and almost disappeared in 2023. Since January, food prices have only risen by 0.7%. This reflects that the supply chain issues that drove price increases in the early stages of the pandemic recovery have now been resolved. In addition, suppliers in the food industry seem to be facing increasing competitive pressures, thus lowering prices, or at least no longer raising them.

The rate of increase in restaurant food prices is still faster than grocery prices, reflecting to some extent the increasing labor costs in the industry. However, competitive pressures also seem to be slowing down the pace of this inflation. The restaurant index rose by 0.2% in July, with a six-month annualized growth rate of 3.4%. If reports from some chain restaurants are credible, inflation in this sub-item will continue to slow down for the remainder of the year.

Rental inflation will continue to slow down

In July, the rent index and the owner's equivalent rent index both rose by 0.5% and 0.4%, respectively. Over the past year, they have risen by 5.1% and 5.3%, respectively. We can foresee that rental inflation will continue to decline, as the new tenant rent index from the U.S. Bureau of Labor Statistics shows a year-on-year actual decrease. With more lease renewals, the rent index of the CPI will follow the trend of the new tenant rent index The rental inflation in the report for July showed some anomalies as it exceeded the 0.3% increase in June. It is almost certain that the rental inflation for August will decrease, with the expected increase in the two rental indices falling back to 0.3%.

Medical service inflation may rebound

The hospital service index unexpectedly decreased by 1.1% in July. With the index previously having an annual growth rate of over 6.0%, the decrease in July may be due to random fluctuations. It is almost certain that it will rise again in August. As the annual growth rate of professional medical services (another major component of the medical service index) exceeds 2.0%, we should expect the medical service index to rise by 0.4%-0.5% in August.

Car prices will continue to decline

There is still significant room for new and used car prices to continue to fall to offset the increases during the pandemic. Since before the pandemic, they have risen by 19.1% and 24.3% respectively. Prior to the pandemic, the annualized increase in new car prices was less than 1.0%, while the annualized decrease in used car prices was about 1.0%.

Due to the significant wage growth in 2021 and 2022 exceeding pre-pandemic rates, these indices are unlikely to fully recover to pre-pandemic levels, but there is still room for further declines this year and in 2025.

Prices of other supply chain-related goods should also continue to decline

Many goods that saw significant price increases during the pandemic continue to decline. In July, furniture prices fell by 1.0%, and prices of washing machines and clothing fell by 0.4% each. Prices of these goods affected by supply chain issues are expected to continue to decline in August.

Prices of transportation services will slightly increase

The motor vehicle maintenance and repair index (which accounts for less than one-fifth of the transportation service index) decreased by 0.3% in July, marking the first decline in over two years. The index has been rapidly rising for most of 2022 and 2023, mainly driven by increases in auto parts prices and rising labor costs. With supply chain issues mostly resolved and the labor market softening, the inflationary pressure on the index is expected to ease, although the decline seen in July is unlikely to recur.

Airfare prices also saw a significant 1.6% drop in July, which is unlikely to be sustained. While the overall trend for airfare prices may be downward, monthly data often fluctuates significantly, so at least a slight increase is expected after the sharp decline.

The car insurance index may be the biggest uncertainty factor in the current CPI. The index rose by 1.2% in July, contributing 0.04 percentage points to the inflation rate for that month. Over the past year, the index has risen by 18.6%, contributing 0.49 percentage points to the year-on-year inflation