US inflation falls in August; Central Bank prepares to cut rates

Inflation continued to ease in August, paving the way for the Federal Reserve to cut interest rates for the first time since early 2020 at its meeting next week.

However, signs of resistance remain beneath the surface, prompting investors to increase their bets that central banks will cut borrowing costs by a quarter of a percentage point from the current 5.33%, rather than the larger half-percentage point cut that some had previously thought possible.

According to The New York Times, the overall Consumer Price Index rose 2.5% in August compared to a year earlier, a notably lower pace of inflation than July’s 2.9% and well below the 9.1% peak recorded in 2022.

But the number that caught Wall Street’s attention on Wednesday was a “core” monthly measure. That gauge reflects price increases between July and August, excluding food and fuel costs, which can be volatile, and rose to 0.3%, slightly above what economists had expected.

The details make this move significant: It occurred alongside a measure of housing prices that has proven surprisingly resilient. Housing costs account for a significant portion of overall inflation, so if these prices don’t cool as expected, they could prevent the pace of price increases from fully returning to the Fed’s target.

Still, that complication hasn’t been enough to alter the overall narrative. Inflation has been gradually declining for some time, allowing the Fed to consider a shift in its policy as officials try to strike a delicate balance between controlling rapid price increases and avoiding an economic collapse.

“I still think they’re confident enough to go ahead with rate cuts, but it suggests they’re unlikely to move too quickly,” said Laura Rosner-Warburton, a senior economist and co-founder of MacroPolicy Perspectives. “We’re not completely out of the woods.”

High interest rates act as a brake on the economy. They slow economic activity, and as demand declines, it becomes harder for businesses to raise prices. However, Fed officials need to proceed with caution. Keeping rates high for too long could slow the economy too much, increase unemployment, and risk a recession.

Fed officials are reluctant to cut rates quickly if there is a possibility that price increases are not fully under control, as that could overheat the economy and make inflation a persistent problem. On the other hand, they also do not want to delay acting and jeopardize the health of the labor market.

That’s why they are closely monitoring inflation and employment data as they assess how quickly to act, both at the two-day meeting that ends next Wednesday and in the months ahead.

Policymakers will present a summary of their future plans next week, when they are expected to release new quarterly economic forecasts outlining a rough path for rates.

The Fed’s action next week will mark an inflection point in the economy, offering the clearest statement yet that central bankers believe they are winning the war on inflation, even if the victory is not yet complete.

After spiking in early 2021, inflation has been slowing for more than two years and is finally approaching a normal pace. Fed officials officially aim for 2% inflation, setting that target based on the Personal Consumption Expenditures price index. That measure uses some data from the Consumer Price Index, but it lags. It, too, has shown modest progress.

Ms. Rosner-Warburton said she expects housing costs to ease in the coming months. However, there could be bumps along the way; for example, she predicts used car prices could rise again this fall.

“The direction of travel is still clear,” she said. “The question is the speed and whether it will be a linear process.”

As price increases approach the Fed’s target, consumers may start to feel a sense of recovery. Wage growth has outpaced price increases for more than a year, according to several measures.

That’s good news for the Biden administration, which has struggled to take credit for its economic wins — including a strong jobs market — as rising prices have sapped consumer confidence.

“With inflation returning to near-normal levels, it is important to focus on maintaining the historic gains we have made for American workers during this recovery,” Lael Brainard, head of the White House National Economic Council, said after the report.