July CPI report: The case for a September Fed pause is building

The July Consumer Price Index (CPI) report showed that inflation continues to make meaningful progress toward the Federal Reserve’s (Fed) 2% target. Annual headline inflation rose slightly, from 3.0% to 3.2%, but core inflation eased from 4.8% to 4.7% as monthly pressures decelerated further. In fact, July marks the second consecutive month that core inflation grew at an annualized pace of just 2%—the case for a Fed policy rate pause, in September, is building.

Consumer Price Index
Year-over-year % change, 2010–present

Report details:

• While annual headline inflation increased in July to 3.2%, the month-on-month number remained at 0.2%, in line with consensus expectations. Core CPI (which excludes food and energy) also rose by 0.2%. On an annualized basis, core CPI rose at a pace of 3.1% over the past three months, the slowest since September 2021, and down from 4.1% and 5.0% in the previous two months.
• Within core CPI, core goods inflation was deflationary once again, falling 0.3% on the month as both new and used car prices fell further. The latest data certainly fits with the Fed's narrative that goods inflation has largely been "solved."
• By contrast, services CPI accelerated from 0.3% month-on-month in June to 0.4%. Shelter inflation, which consists mainly of rents and owners’ equivalent rents, accounted for 90% of July’s increase in inflation. Note that the slowdown in rents a year ago should lead to a waning in shelter costs in the coming months. However, any resurgence in the housing market would put renewed upward pressures on the segment.
• Core services ex-housing inflation, often referred to as “supercore inflation,” showed a potentially concerning development in the July report, accelerating by 0.2%. This gauge, closely watched by Fed Chair Jerome Powell due to its link to the labor market, had flatlined the previous month.

Overall, inflation is showing sufficient progress to keep the Fed on the sidelines at their September meeting. However, the renewed increase in the supercore inflation measure and signs of housing market recovery suggests that the Fed cannot rest just yet and is still some distance from cutting rates. Disinflation is unlikely to be smooth and will require some additional economic pain before the 2% target comes sustainably into view.