Broad-based inflation gains unlikely to repeat

While the consumer price index climbed 0.3% in July, as did the core rate, the broad-based increases are unlikely to continue, according to analysts.

The Federal Reserve shrugs off single month spikes or drops, and therefore, hasn’t impacted greatly the market’s belief the Fed will again cut rates 25 basis points in September.

Gas prices, medical care costs and housing all contributed to the climb in the index, the Labor Department reported Tuesday. CPI rose 1.8% on an annual basis, up from 1.6% in June, while the core rate was 2.2% higher than a year ago, up a tick from the prior month.

Economists polled by IFR Markets expected CPI to grow 0.3% in the month, 1.7% year-over-year, with the core up 0.2% in the month and 2.1% year-over-year.

“Gains in the CPI were broad-based in July and deserve close scrutiny,” Berenberg Capital Markets Chief Economist U.S., Americas and Asia Mickey Levy and U.S. Economist Roiana Reid write in a note. “But we doubt this momentum will be maintained. U.S. nominal GDP growth has decelerated to 4% from 6% in mid-2018, which has reduced businesses’ flexibility to raise prices. Without an acceleration in nominal spending growth, inflation is unlikely to rise on a sustained basis.”

Indeed, the July producer price index core rate fell to a 2 ½ year low, suggesting “inflationary pressures are benign,” they wrote. “The strong dollar has led to declines in nonpetroleum import prices, and spot commodity prices and market-based measures of inflation expectations continue to decline.”

Medical care, apparel, used car, alcoholic beverages, tobacco and transportation service prices were the “most noteworthy.”

The gains in the core index are “unlikely to be sustained as some of the more volatile categories are expected to recede,” Levy and Reid write.

The continued moderate rise in inflation has helped push up inflation-adjusted wage gains, they added, “This adds to real disposable personal income and consumer purchasing power.”

Consumers have been fueling the expansion as business spending has been weak.

Despite these gains in inflation, the personal consumption expenditures, the Fed’s preferred inflation measure should remain below 2% when it’s released later this month.

However, “inflation expectations have taken a nose dive according the breakeven inflation rate on TIPS (the difference in yield between an inflation protected Treasury bonds and an equivalent maturity traditional Treasury yield),” said Bryce Doty, senior vice president/senior portfolio manager at Sit Fixed Income.

The breakeven rate fell from about 2% in April to 1.62%, he noted. “Considering the year-over-year core rate at 2.2% and the inflationary influence of tariffs, TIPS look cheap right now.”

Other news
Small business owners are more optimistic about business conditions, as the National Federation of Independent Business’ July Small Business Optimism Index gained to 104.7 from 103.3.

Seven of its 10 components rose, while two slipped and one was steady.

“Contrary to the narrative about impending economic doom, the small business sector remains exceptional,” according to NFIB Chief Economist William Dunkelberg. “This month’s index is a confirmation that small business owners remain very optimistic about the economy but are being hamstrung by not finding the workers they need.”

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