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Energy pushes inflation higher but core prices remain grounded

REAL ECONOMY BLOG | September 13, 2023

Authored by RSM US LLP

Consumer inflation in August posted the biggest monthly increase in more than a year, driven mostly by the surge in oil and energy prices, the Bureau of Labor Statistics reported on Wednesday.

August’s increase will most likely not be enough to steer the Fed from holding rates steady next week.

But core inflation—which has more policy implications—grew slightly faster at 0.3% or 2.8% on a three-month moving average annualized pace, closer to the Federal Reserve’s long-term inflation target rate of 2%.

August’s increase—driven by a 5.6% increase in energy prices on the month, up significantly from a 0.1% gain—will most likely not be enough to steer the Fed from keeping its policy rate steady at its meeting next week. Several Fed officials have already telegraphed a pause in recent weeks.

The bigger question, though, is whether the stickiness of inflation can change the Fed’s mind starting in November, when the labor market and consumer spending are likely to prove more resilient than expected.


The large increase in monthly inflation in August already reversed the disinflation of the headline year-over-year number, rising for the second month in a row to 3.6% in August from 3.2% in July and 3.0% in June.

Still, we expect the Fed to see through the volatility in oil and food prices and hold rates steady until the end of the year. The predicted declines of two of the biggest components of inflation—automobiles and shelter—should help core inflation to stabilize further.

The headline year-ago core inflation declined for the fifth month in a row, falling to 4.3% in August.

More important, while we have upgraded our forecast to 60% that the economy will have a soft landing over the next 12 months, we do not expect the same level of spending and labor market growth in the last quarter of the year.

Contribution to CPI

With interest rate increases still working their way through the economy, a period of uncertainty and muddling through is our base case for the rest of the year.

Increasing uncertainties have already started to pop up as the standard deviation of the market forecasts, including ours, for August’s inflation surveyed by Bloomberg was the largest in five months.

Our call for the policy rate peaking at the current level of 5.5% depends entirely on whether the Fed will take this chance to update its long-term inflation target to more than 2%, which has been the agency’s north star for a couple of decades.

Given how the economy will drastically change in the post-pandemic era, we think it is more realistic for the Fed to quietly increase its inflation target to 2.5% to 3% in the near term until the central bank is ready to reassess its policy.

If the Fed continues to push for 2% in the next quarter or so, it will require more rate hikes, which risks putting the economy into an unnecessary recession.

Inside the data

The closely watched core services less shelter picked up sharply on the month to 0.53% from 0.22% previously. The increase might work into the hawks’ favor for more tightening as the so-called super-core inflation rate is the Fed’s key gauge into underlying inflation and wage pressure.

But the significant uptick might be short-lived as it was driven mainly by robust spending in the last month of the summer, reflected by a slower decline in goods inflation (down by 0.1% versus 0.3% previously), and a sharp increase in airfare (up by 4.9% versus down by 8.1% previously).

Shelter inflation dropped to 0.3% after remaining at 0.4% for two months in a row, further signs that cooling housing and rental prices have worked through.

Food prices remained growing at 0.2%.

The takeaway

For many months, we have argued that once disinflation and a slowing economy take hold, the Fed would have to rebalance its priorities between price stability and economic growth, which have been pretty much one-sided toward inflation in the past two years.

The Fed won’t be able to rely on a tight labor market much longer as labor demand is often a lagging indicator. There are plenty of signs that point to a further slowdown in the coming months. Another rate shock is the last thing the economy needs during this pivotal point of the business cycle.

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This article was written by Tuan Nguyen and originally appeared on 2023-09-13.
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