US inflation jumps less than expected! Further rate hikes look uncertain!

Headline CPI inflation in the United States accelerated from 3.0 to 3.2% YoY in July, which was a reading slightly lower than 3.3% YoY expected. Core CPI slowed from 4.8 to 4.7% YoY while both monthly gauges (headline and core) came in at 0.2% MoM - in-line with market expectations, long-term averages as well as reaching Fed's inflation target by 2025. Will the Fed continue to hike in such circumstances?

There was a concern that higher fuel prices will translate into a bigger jump in US CPI in July, and that this trend will continue in August. However, it turns out that higher energy prices were offset by declines and smaller-than-expected increases in other categories. Prices of used and new cars were prime decliners. Interestingly, electricity prices also dropped in spite of a quite significant pick-up in US natural gas prices, which is an important fuel in the US for power generation. The biggest drop, however, was reported in airline fares but this item has a very small weight of just 0.6% in overall US CPI. While fuel prices are important and have risen noticeably in July but shelter continues to be a key driver of US inflation. Shelter has a weight of 34.7% in US CPI and prices in this category grew by 0.4% MoM and 7.7% YoY in July. However, it should be noted that shelter data tends to be lagged and its contributions to US CPI should start to decline in the coming months.

From the Fed's point of view, inflation data for July gives more comfort to keep rates unchanged at the September meeting and assess the situation. Should US jobs data for August disappoint and CPI report for August does not show any big rebound, rate hike at September meeting would look very uncertain. Views among Fed members are split. However, it should be noted that Harker, who is considered to be one of Fed's biggest hawks, suggests the possibility of keeping rates unchanged. Fed will look primarily at core inflation and would prefer to see no rebound in the annual growth rate and a monthly increase that would be in-line with the inflation target. Of course, further rebound in energy prices may push headline CPI higher by the end of the year but as energy prices are absent in core inflation and outside of Fed's control, US central bankers may rule that their actions so far indeed limited inflation.

US dollar experienced a negative reaction to the release and EURUSD continues to trade above the 1.10 mark. Equity indices gained, what is also in-line with a 'dovish' tone of today's CPI data. Money markets have also trimmed their hawkish bets and now price in just a 10% chance of a rate hike at September meeting and around 20% chance of such a move at November meeting.

Filip Kondej CFA
Financial Markets Analyst