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Easing US inflation has raised the prospects that the interest rate increase expected from the Federal Reserve later this month will be the last of its historic monetary tightening campaign.
The lower-than-expected increase in prices reported by the Bureau of Labor Statistics on Wednesday showed a welcome reprieve in sources of inflation that had proven to be stubbornly persistent.
“Core” inflation, which strips out volatile food and energy prices, registered a monthly gain of only 0.2 per cent in June, the smallest increase in nearly two years. Annual headline inflation is now running at 3 per cent, its slowest pace since March 2021.
Despite the consumer price index data, the Fed is still widely expected to plough ahead with another quarter-point interest rate increase at its next policy meeting later this month, after forgoing an increase last month. But economists now see dimming prospects the central bank will need to raise borrowing costs beyond that point.
“Disinflation is going to kick into a bit higher gear in the second half of the year,” said Andrew Schneider, US economist at BNP Paribas. He expects the July rate rise to be the Fed’s last of this tightening cycle. That translates to the federal funds rate topping out at 5.25-5.5 per cent, a level he forecasts the central bank to maintain at least through the early part of next year.
According to fed funds futures markets following the June inflation data, traders are also now increasingly convinced the central bank will call time on interest rate increases after its gathering this month.
Ceasing to raise rates beyond July would mark a departure from the projections published by the Fed in June, which showed that most of its policymakers forecast two more quarter-point rate rises this year. Jay Powell, the chair, last month described that trajectory as “a pretty good guess of what will happen”, but stressed the Fed would closely monitor incoming data as it determined its next policy steps.
Lael Brainard, the director of the National Economic Council at the White House and a former Fed vice-chair, was upbeat about the inflation data and the wider US economy.
“The economy is defying predictions that inflation would not fall absent significant job destruction,” she told the Economic Club of New York on Wednesday.
Annual CPI growth had eased for 12 months in a row, was close to the average before the financial crisis, and was the lowest among G7 nations, she added. Meanwhile, the labour market was “in a better balance” than it had been earlier in the year, she said.
For Omair Sharif, president of forecasting group Inflation Insights, what will give the Fed “ammo” to forgo a rate rise in September and beyond is not only that the more moderate monthly pace of core inflation looks set to be sustained but also that price rises are easing across more spending categories in goods and services.
Sharif said core inflation in July, August and September was likely to average just 0.2 per cent in each month.
“If that forecast comes to fruition, then the Fed is getting exactly what they wanted to see, [which is] a string of readings showing you that the core numbers are really coming off and the breadth of disinflation has really improved,” he said.
One complicating factor is that the policy-setting Federal Open Market Committee remains divided, with more hawkish voting members such as Lorie Logan of the Dallas Fed and governor Christopher Waller still chiefly concerned about upside risks to inflation.
Logan recently admitted she would have supported a rate rise in June in light of economic data she described as “pretty hot” and signs that the housing market has “bottomed out”.
Diana Amoa, chief investment officer at Kirkoswald, said she expected the Fed to keep all options open following its July meeting, citing lingering concerns about inflationary pressures amid a strong labour market and officials’ caution on stoking market expectations that they will soon slash interest rates.
“They can’t really be too explicit that they’ve come to the end of the hiking cycle simply because markets struggle with pricing in rates on hold for a prolonged period of time,” she said. “They will want to keep being data dependent and continue signalling that they need inflation to be at target.”
Additional reporting by James Politi in Washington
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