Humid July CPI report puts pressure on Fed to hike

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• Key insight: Headline inflation increased by 0.1% last month for an annualized growth rate of 3.4%. The reading could push some policymakers to support tighter monetary policy.
• Expert quote: “If I do not see signs of continued disinflation soon, I am prepared to act. With five years of above-target inflation, the risk grows that higher inflation may become entrenched in price- and wage-setting behavior, leading to persistence that would be much harder for us to attack.” — Federal Reserve Gov. Lisa Cook
• Forward Look: With opinions split on the Federal Open Market Committee about how urgently to address rising prices, the July CPI reading undercuts arguments about an underlying disinflationary trend.

Pressure could be mounting on the Federal Reserve to raise interest rates after inflation regained steam in July. 

After a slight reprieve in June, progress on inflation appears to have stalled in July, according to the Bureau of Labor Statistics’ latest consumer price index report. It shows prices ticked up by 10 basis points in July for a headline inflation rate of 3.4% year over year. Core inflation, which factors out food and energy, rose 2.5%.

Both the headline and core rates were in line with economic forecasts ahead of the report. They also matched the prints from June. Because inflation did not improve, the outcome bolstered arguments that inflation is persistent, broad-based and in need of containment.

“When I look at policy broadly, I don’t see any tension in our mandate. We’ve been missing on the inflation side for more than five years, but the labor market is right around my estimate of full employment,” Cleveland Fed President Beth Hammack said earlier this week. “I don’t think policy is restrictive, meaningfully restrictive at this point.”

In an interview with Yahoo Finance, Hammack argued that the Federal Open Market Committee should have hiked rates at its meeting last month and suggested that multiple increases might be in order. 

“I would say in general, one 25 basis point move probably doesn’t do a whole lot for the economy, so it’s probably, you know, some number of movements,” she said. “But, I don’t want to prejudge what that number is going to be.”

Hammack was one of three FOMC members in July to vote against keeping their benchmark interest rate unchanged, preferring to raise rates by 25 basis points. Wednesday’s inflation print underscores their argument and could sway other committee members who said they would favor a hike if they don’t see evidence of disinflation. 

“If I do not see signs of continued disinflation soon, I am prepared to act,” Fed Gov. Lisa Cook said in a speech last week. “With five years of above-target inflation, the risk grows that higher inflation may become entrenched in price- and wage-setting behavior, leading to persistence that would be much harder for us to attack.”

Others in the nine-member majority from last month’s meeting have also emphasized the upside risk to inflation in recent public comments, including Fed Gov. Christopher Waller and Philadelphia Fed President Anna Paulson. 

The decision to hold rates steady, while expected, was met skeptically by some market participants, many of whom viewed Fed Chair Kevin Warsh’s explanation of the hold call lacking in substance. During his post-meeting press conference, Warsh said inflation was too high and pledged that the Fed would tamp down on it, but he declined to outline the group’s precise thinking on the subject.

Wednesday’s CPI report follows an unexpectedly poor labor market reading last week. Coupled with June inflation data that showed a marked improvement from May’s red hot reading, the jobs report weakened arguments for a hike, but July’s pricing print could shift the balance of risks back toward price stability. 

The market response to the inflation report was muted. Ahead of the release, 54% of federal funds rate futures contracts had priced in a hold in September while the rest of the market called for a hike. After the report was published, the hold position rose to 58%.

The Fed still has more than a month to dissect economic data as it weighs whether or not to adjust interest rates at its September meeting. Before then, it will receive the Bureau of Economic Analysis’ personal consumption expenditure report — the central bank’s preferred inflation measure — as well as August jobs and CPI reports next month. 

In the meantime, Warsh is due to deliver his keynote speech at the Fed’s Jackson Hole Economic Policy Symposium in two weeks. Typically, Fed chairs use the event to outline the central bank’s intended course of action for the remainder of the year, but Warsh has steadfastly refused to engage in any type of communication that could be considered forward guidance.

“Historically, at least for my first tour of duty at the Fed, the more recent periods — it would be sort of a setting-up speech more often than not — of what was going to be happening in the fall,” Warsh said during his press conference. “I haven’t made any judgments on that. But those are judgments we’ll have to come to.”