U.S. core Consumer Price Index (CPI) inflation was firmer than expected in July, increasing 0.3% month-over-month, similar to June’s gain, and the year-over-year rate ticked up to 2.2%. We have been flagging the risk that businesses could pass on the higher costs associated with import tariffs more aggressively, and early evidence suggests this is happening. We now expect the year-over-year rate of core CPI to drift up to 2.5% over the next several months.
While the strong June and July readings are awkward for Federal Reserve officials, who are likely to cut rates again in September and possibly more later this year, we think they will look past it given that much of the firming is happening in retail goods categories subject to tariffs – and therefore temporary. Moreover, the news that the U.S. is removing certain products from the list subject to Chinese import tariffs set to go into effect on September 1, and delaying to December 15 tariffs on items that can’t be easily sourced from other countries – including cellphones, laptop computers, video game consoles, certain toys, computer monitors, and certain footwear and clothing items – could further ease related inflation concerns. With inflation expectations more or less anchored, the risk that tariffs kick off an inflationary spiral appears much lower than the downside risks to real growth from trade and tariff uncertainties and slower global growth.
Inflation marches on despite ‘Prime Day’ discounts
The firming in July came despite reports of broad-based sales promotions around Amazon Prime Day on July 15, with businesses appearing to pass on a greater portion of the higher goods import tariffs. The pace and magnitude of consumer price adjustments have been somewhat more aggressive following the May tariff announcements, prompting us to incorporate a somewhat higher rate of pass-through for the wider range of goods subject to tariffs after the “Tranche 4” announcement on August 1 (despite some products being removed from the list and the others delayed until December). We now expect retail goods inflation to reach 1% over the next several months – a pace that hasn’t been witnessed since early 2012.
Services categories hold firm
Meanwhile, core services prices gained 0.3% month-over-month, with support from solid gains in shelter services. Lower vacancy rates and the lagged effects of rising wages and higher interest rates (which make owning a home comparatively less affordable) are supporting housing inflation. Eventually, the more recent decline in rates and a slower pace of wage gains will help cool CPI-reported housing services inflation; however, based on the historical lags, inflation in these categories should hold firm over the next several quarters.