Near-target inflation fuels hope of soft landing for economy

REAL ECONOMY BLOG | August 10, 2023

Authored by RSM US LLP

Inflation stabilized further in July as the consumer price index data met expectations, the Bureau of Labor Statistics reported on Thursday.

The slight uptick in annual inflation to 3.2% from 3.0% could be dismissed due to the base year effect, as inflation has come down fast from a peak in June last year.

Our focus is on monthly inflation, which grew at 0.2% in July and 2.0% on a three-month moving average annualized basis, running exactly in line with the Fed’s long-term target.

Stripping away the volatile components, several measures for core inflation also stabilized around the 0.2% monthly increase threshold. Core inflation, excluding food and energy, rose 0.2%, while core services excluding shelter—the Fed’s top priority—also rose 0.2% on the month.

Thursday’s CPI data should give the Fed more relief as its highly anticipated September meeting approaches. The report indicated no reason that the central bank will hike interest rates further, as price gains were in line with the target rate.

That said, as the inflation plane descends, we should expect some turbulence along the way. It has been somewhat of a smooth ride from the top at 9.1% to slightly above 3% on an annual basis in only about a year. However, the journey from 3% to 2% will certainly force the Fed to keep rates restrictive if it is determined to do so.

Given the continuing disinflation and economic slowdown, the chance of a soft landing has never been higher since the Fed began its rate hike campaign to restore price stability. But the closer we get to a coin-flip situation, the more difficult it will be for the Fed to distinguish between recessionary and soft-landing signals and to balance between the two mandates—price stability and employment growth.

There is always a possibility that inflation can pick up steam as the economy is able to skirt a recession. Some concerns over energy prices due to supply issues have already been in the pipeline ahead of the next CPI data release for August.

But more relief from the housing component will work in the Fed’s favor;  our estimate pointed to further declines for the top-line annual price gains within the housing sector in the second half of the year.

Thus, we expect the Fed to keep rates steady between a range of 5.25%-5.5%, at least through the remainder of this year as top-line inflation averages around 3% by year’s end.

The data

Despite earlier concerns, energy prices only picked up slightly on the month at 0.1%, remaining significantly lower than last year’s price increases, as the annual rate stayed at minus -12.5%. Still, the sector will be the one to watch in the next release as a rebound in price increases is guaranteed.

Shelter grew 0.4% on the month, unchanged from June, while the year-ago change was 7.7% in July, down slightly from 7.8% in the prior month.

Inflation in the services sector remained sticky, showing a 6.1% increase, down from 6.2% in June. On the flip side, goods inflation continued to be the lifesaver, as year-ago goods prices grew only 0.8% in July and were down 0.3% on a monthly basis.

Food prices continued to stabilize at 0.2% month-over-month, yet remained elevated at 4.9% on a year-ago basis.