Key Takeaways
- Inflation as measured by the CPI likely continued to accelerate in July, rising to a 2.9% annual increase from 2.7% in June, according to forecasters.
- Inflation measures such as the CPI show the effects of tariffs as companies pass import taxes along to consumers.
- Rising inflation could put the Federal Reserve in a dilemma: lower interest rates in September to boost the economy and preserve the job market, or keep them high to prevent inflation from surging.
A key inflation measure likely accelerated in July, as tariffs continued to push up prices for consumers.
A highly anticipated report from the Bureau of Labor Statistics Tuesday is likely to show the Consumer Price Index rose 2.8% over 12 months as of July, up from a 2.7% annual increase in June, according to a survey of economists by Dow Jones Newswires and The Wall Street Journal. That would be the highest inflation rate since February, and an indication that President Donald Trump’s trade wars are squeezing household budgets.
A report matching expectations would be the second CPI reading in as many months, showing companies passing at least some of the cost of tariffs along to consumers. A major question for the economy’s trajectory is whether tariffs will cause a short-lived burst of price increases or whether high inflation will set in.
“This is not likely a prelude to spiraling inflation, but it is clearly the wrong direction,” Dean Baker, senior economist at the Center for Economic and Policy Research, wrote in a commentary.
Economists and officials at the Federal Reserve have closely watched “core” inflation measures to help answer that question. Core inflation, which excludes the volatile prices for food and energy, is expected to accelerate to a 3.1% annual increase in July, also its highest since February, up from 2.9% in June, according to the median forecast.
The Fed manages the nation’s monetary policy to keep core inflation at a 2% annual rate. The central bank uses a different inflation measure, PCE, as its benchmark rather than CPI, although the two inflation gauges tend to move in the same direction.
Prices for heavily tariffed items including appliances, clothing, recreation products, cars, and certain foods likely rose rapidly in July, Baker said. Rent, on the other hand, likely rose slowly, easing some of the financial pressure on consumers from tariff price hikes.
Tariff-related price increases simmered earlier in the summer in the wake of Trump’s far-reaching campaign of raising import taxes, which began in the spring. The tariffs have raised prices of a wide variety of things brought in from other countries, although the effects have taken some time to show up on price tags, as some companies stockpiled merchandise before the tariffs took full effect.
“The initial effect of tariffs on consumer goods prices has been blunted by some pull-forward of inventories and reluctance among businesses to immediately pass on higher costs with tariff rates not yet settled,” economists at Wells Fargo, led by Sarah House, wrote in a commentary. “Yet, the toll on U.S. importers is becoming clearer.”
Inflation has cooled significantly after surging in the aftermath of the pandemic. However, inflation has hovered uncomfortably above the Fed’s 2% target this year, and another uptick in July could signal it’s trending upwards again.
The Fed Is Between A Rock And A Hard Place
Tuesday’s report could be crucial for Fed officials, who set the nation’s monetary policy to keep inflation low and employment high.
Accelerating inflation could pressure the central bank to keep its key interest rate at a higher-than-usual level when the Fed’s policy committee next meets in September. The relatively high federal funds rate keeps upward pressure on interest rates on all kinds of loans. It is meant to discourage borrowing and spending, slowing the economy and pushing inflation down. Fed officials have kept the rate at 4.25%-4.50% all year, partly out of concern that tariffs could stoke inflation.
However, the Fed is also under pressure to cut interest rates to boost the economy and prevent a severe increase in unemployment, given recent reports on the job market showing hiring is unexpectedly grinding to a halt.
The Fed faces a dilemma: cut rates at the risk of reigniting inflation or keep them high and risk dragging the economy into a recession. Financial markets are betting the Fed will deliver the first rate cut of the year in September. Traders are pricing in an 86% chance of a rate cut, according to the CME Group’s FedWatch tool, which forecasts rate movements based on fed funds futures trading data.
A report in line with expectations would likely keep those expectations intact, economists said.
“All told, July’s CPI report is unlikely to drive markets to reassess the chances of Fed policy easing over coming months,” economists at Pantheon Macroeconomics, led by chief U.S. economist Samuel Tombs, wrote in a commentary.
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