Inflation, as measured by the Consumer Price Index, continued to tick up last month. The July CPI registered a gain of 0.2% versus June. Year over year, the measure was up 2.9%, the largest annual increase since 2011. Excluding the volatile food and energy categories, CPI rose 2.4% year over year.
CPI ex Food & Energy Y/Y
Driving the gains were increases in “owners’ equivalent rent,” which essentially measures shelter costs. A 0.3% rise in this category accounted for 60% of the increase in the overall level of CPI. The strong economy is also contributing to an increase in prices, with certain service items, such as hotel rates and airline fares, posting solid gains and reversing declines in June.
For us, there are two key takeaways from the report.
First, a steadily increasing level of inflation will likely keep the Fed on track for a rate hike at their September meeting. The Fed has recently expressed confidence that inflation is coming back to levels more consistent with their 2% target. And although the CPI is not the Fed’s preferred measure of inflation (that is reserved for the personal consumer expenditure index), it does indicate that inflation is running at levels consistent with the Fed’s objectives.
Second, and something that we will be watching moving forward, is whether consumers can stomach higher levels of inflation given that wage growth remains tepid. In addition to CPI, average hourly earnings were released last week and showed that wage gains are not keeping up. For the first time since 2012, wage gains after accounting for inflation turned negative.
Given that strong consumer spending has been a boost to the U.S. economy, any reversal could have negative impacts for GDP growth in the future. And with inflation registering at these levels, we shouldn’t expect the Fed to scale back on their monetary policy normalization process anytime soon. Tighter policy with weaker growth typically makes for volatile markets, so it will be important to see how consumers react to lower real wages and if they dip into savings to keep the spending going.
Sources: Bloomberg, Labor Department, WSJ