August CPI Report Highlights Stubbornly High Inflation

Key Takeaways

• Inflation accelerated in August as oil and gas prices rose, according to the Bureau of Labor Statistics.
• Rising energy prices likely contributed to hotter-than-expected core inflation, which excludes the direct effects of food and energy prices.
• The odds of a September rate hike shot up to nearly 90% following Friday’s report.

The August Consumer Price Index report showed inflation remained elevated as rising energy prices rippled through the economy. Analysts say the data casts doubt on the Federal Reserve’s progress in returning inflation to its 2% target and raises the odds that the central bank will raise interest rates next week.

The latest CPI report showed that August core inflation, which excludes volatile food and energy prices, was firmer than expected last month, driven by rising airfare, hotel, and telecommunications prices.

The CPI increased 0.4% in August, in line with expectations and hotter than the 0.1% rise in July, according to the Bureau of Labor Statistics. On a year-over-year basis, headline inflation held steady at 3.4%, just above economists’ consensus expectations, according to FactSet.

“Anyone hoping for a cooling, or at least moderation, of core CPI will be sorely disappointed,” writes Chris Zaccarelli, chief investment officer at Northlight Asset Management.

August CPI Inflation Report Highlights

• CPI rose 0.4% for the month after rising 0.1% in July.
• Core CPI rose 0.3% in August after increasing 0.2% in July.
• CPI increased 3.4% year over year, as in July.
• Core CPI rose 2.4% over the year, down from 2.5% in July.

Energy prices drove August’s accelerating inflation, according to the report. The gasoline index rose 3.9% month over month, accounting for more than one-third of the headline CPI increase.

Core CPI inflation also accelerated month over month to 0.3% from 0.2% in July. The annual core rate ticked down to 2.4% from 2.5%. Shelter costs increased 0.3%, driven by a 2.4% increase in lodging away from home. Rent and homeowners’ equivalent of rent, which constitute about one-third of overall CPI, held steady at 0.2%, which Oxford Economics lead US economist Bernard Yaros writes is unlikely to accelerate, considering the economy’s modest job creation and rising rental vacancies.

Core services inflation at 0.33% surprised to the upside, “which matter[s] to the Fed, as these reflect domestic demand,” writes Yaros. The airfare, motor vehicle maintenance, lodging away from home, and wireless telephone services indexes all accelerated last month.

That said, some economists are taking the pickup in services prices with a grain of salt. The rise in wireless telephone services, which added a tenth of a point to core inflation last month, “likely reflects AT&T’s retirement of certain unlimited plans and higher administrative fees, which should prove to be a one-off,” wrote Stephen Juneau, US economist at Bank of America Securities, on Friday. He adds that hotel prices and airfares, which added nearly a tenth of a point to core inflation, are notoriously volatile.

At the same time, economists say rising energy prices remain a danger the Fed can’t ignore. Accelerating transportation services inflation “is a reminder that the pass-through of energy costs to a broader set of consumer prices is a key upside risk,” Yaros writes.

The conflict in the Middle East has continued to push oil, gas, and other fuel prices higher this month, with West Texas Intermediate futures hitting a nearly four-month high above $100 a barrel on Thursday. The average price of a gallon of diesel rose above $6 for the first time earlier this week.

What the August CPI Report Could Mean for the Fed

Economists and investors seemed to agree on Friday that August inflation ran too hot for the Fed to sit on the sidelines next week. The market-implied odds of a quarter-point rate increase at next week’s Fed meeting jumped to 87% Friday morning from 72% Thursday. Investor expectations for a September hike increased steadily over the past month as energy prices climbed and data showed a stable if lethargic labor market.

Many economists assessed Friday’s data would nudge the Fed toward raising rates. “Today’s data all but lock in a rate hike next week,” writes BofA’s Juneau, who says the bond market’s reaction to Friday’s report—the yield curve flattened as long-term yields dipped and shorter-term yields rose—reflected the market’s “increased confidence” in the Fed’s determination to fight inflation. He says that not hiking rates after today’s data could damage the Fed’s credibility and risk a selloff at the long end of the yield curve, as happened after July’s meeting. “We suspect policymakers have learned that lesson.”

Bill Adams, chief US economist at Fifth Third Commercial Bank, writes: “For the Fed, it might have been possible to read the August CPI report as glass half full if nothing else were in the news. But this week’s energy price spike overshadows the August inflation reports.”