United States: Headline Inflation Drops to 2.5%

Headline inflation falling to just 2.5% is clearly good news. This is the lowest print we’ve seen since February 2021 and a world away from June 2022’s 9.1% peak. However, the lack of progress on core inflation, which excludes food and energy, casts a cloud over this performance. Although core inflation has come down substantially from its peak of 6.6% in September 2022, the pace has slowed in the last two months.

Energy prices, which dropped 0.8% in August, are behind the relatively low headline inflation print. Gasoline prices fell 0.6% in August and are expected to drop further in September. This month’s reading brings the year-over-year change in energy prices to -4%, which is helping to rein in inflation. Meanwhile, food prices rose 2.1% year-over-year, a huge improvement compared to the almost 11% y/y increase we saw in summer 2022.

Although progress on core inflation has been somewhat limited in the past few months, the price of goods (excluding food and energy) isn’t to blame. Month-over-month, goods prices fell 0.2% in August, the sixth consecutive month without growth, while the year-over-year change dropped to -1.9%. Prices of used cars and trucks fell again in August, while new vehicle prices were flat, and apparel prices increased 0.3%.

Service prices (excluding energy) disappointed once again, rising 0.4% month-over-month in August, the fastest pace since April. Shelter costs surged 0.5%, their quickest rate since January. Within the shelter index, owners’ equivalent rent, home insurance and lodging away from home all accelerated. If we exclude shelter, the situation remains fairly stable with 0.3% growth in core services prices in August. Prices for transportation services jumped 0.9%, including a 3.9% surge in airline fares after five consecutive months of decline. The 3‑month annualized change in the price of core services excluding shelter—a data point that the Federal Reserve (Fed) monitors closely—accelerated from 0.5% in July to 1.9% in August. While this new pace isn’t alarming, this pick-up could lead the Fed to remain cautious when it starts to ease monetary policy.

Headline inflation is clearly moving in the right direction, giving US voters some relief in the run-up to the election. However, the stickiness of core CPI is evidence that the fight against inflation hasn’t been won yet. The economic climate and inflation picture no longer warrant such high key interest rates. We expect the Fed to cautiously start cutting rates by 25 basis points at next week’s meeting.