U.S. inflation slowed last month and a measure of underlying price pressures also cooled, suggesting higher oil and gas prices from the Iran war are only having a limited impact on broader costs in the economy.
Consumer prices rose 3.4 per cent in July from a year ago, down slightly from 3.5 per cent in June, the Labor Department said Wednesday. But inflation is still higher than before the Iran war began in February, when it was 2.4 per cent. On a monthly basis, prices rose just 0.1 per cent from June to July.
Inflation has been pushed higher by a series of shocks to the economy, including U.S. President Donald Trump’s tariffs imposed last spring, higher gas prices stemming from the Iran war, and a surge in investment in artificial intelligence infrastructure that has boosted computer chip prices.
The key question for the inflation-fighters at the Fed — not to mention for consumers struggling with high gas and grocery prices — is how quickly those one-time effects will fade.
Excluding the volatile food and energy categories, core inflation rose also slipped to 2.5 per cent in July from a year ago, down from 2.6 per cent in June. Core prices rose 0.2% from June to July. Monthly increases at about 0.2 per cent would be low enough over time to bring inflation closer to the Fed’s two per cent goal.
Wednesday’s figures could bolster officials at the Federal Reserve who believe the central bank can leave its key rate on hold at about 3.6 per cent while inflation steadily declines on its own as those temporary factors fade.
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Americans have grappled with worsening inflation since early last year, after tariffs lifted the cost of imported goods. Then this spring, the Iran war raised oil and gas costs, pushing inflation to its highest level in three years. The AI build out has also increased prices for computer chips and electronic equipment.
All three trends could end up having only temporary effects and if they fade, inflation could drop back to the Federal Reserve’s two per cent target.
A big reason inflation has cooled in the past couple of months is that gas prices fell after a ceasefire was reached in the U.S.-Iran war.
Average gas prices were lower last month than in June, so that should reduce last month’s inflation reading. But gas prices rose again in late July and earlier this month, meaning inflation could pick up again when August’s figures are released next month, adding a layer of uncertainty.
On Wednesday, gas averaged US$4.04 a gallon nationwide, 16 cents higher than a month ago, according to the motor club AAA.
Overall, price increases have stayed above the Fed’s two per cent target for more than five years, suggesting that more than temporary factors may be at work. The cost of services such as healthcare, restaurant meals, and car maintenance are on average rising at more than three per cent annually, and they aren’t particularly sensitive to gas prices or AI investment.
Rising costs for services often reflect higher wages, as companies charge more to offset the cost of higher pay. But incomes aren’t growing fast enough to sustain inflation, economists note.
It’s a confounding situation that has left many economists — and Fed officials — seeking more information to determine where inflation is headed.
“You’ve got all these things that are just not the way the economy used to behave,” Diane Swonk, chief economist at KPMG, said.
For many consumers, years of sharply rising grocery prices have led them to adopt a wide range of coping strategies, from comparison shopping, to couponing, to cutting back on favorite foods.
Some retailers, such as Walmart, have responded by rolling back food prices, a trend that could have lowered July’s inflation figures. Yet many other firms are still passing on higher costs.
Paint company Sherwin-Williams is planning an eight per cent price increase effective Sept. 1 to offset higher raw material costs, CEO Heidi Petz told analysts late last month. She said that because of the company’s strong relationships with suppliers, it was able to delay price increases until now.
“We are seeing the impact of higher oil and related cost pressures, and we expect continued volatility throughout the balance of the year,” she said.
Iran war stokes inflation, ‘oil poverty.’ How long until prices calm down?
Wednesday’s report comes as the Federal Reserve is sharply divided over whether it should hike its key interest rate to combat inflation. The Fed kept its rate unchanged, at about 3.6 per cent, at a meeting late last month. But the vote was 9-3, with three dissenters favoring a rate hike.
And at a July 29 news conference explaining the decision, chair Kevin Warsh was vague about the Fed’s next steps, in keeping with his focus on reining in the central bank’s previous willingness to signal whether it was prepared to raise or cut borrowing costs.
“If inflation continues to be elevated … interest rates could well be part of that solution,” he said. “But I wouldn’t say it’s in isolation.”
Long-term interest rates rose after Warsh’s comments, suggesting investors worried that inflation could worsen in the coming months and the Fed might not lift borrowing costs to fight rising prices.
Complicating matters, the government said last week that employers had cut jobs in July, a sign of potential economic weakness. The Fed typically avoids rate hikes when hiring is faltering, because higher borrowing costs could slow the economy further.
Investors now see the odds of a rate hike at the Fed’s next meeting in September as roughly 50-50, according to CME Fedwatch.
