Inflation heated up last month, boosting the case for a Fed rate hike

Consumer prices rose at a 3.4% annual rate last month, the same pace as July, according to the latest Consumer Price Index from the Bureau of Labor Statistics. That likely strengthens the case for a Federal Reserve rate hike to tame inflation and prevent price increases from becoming more entrenched. Inflation has accelerated since the war with Iran began, and central bankers are watching to determine whether price pressures are spreading through the economy. Fed officials are set to meet next week to decide the next move on interest rates. On a monthly basis, prices rose 0.4%, an acceleration from July’s 0.1% rate. Gasoline prices, up 3.9%, accounted for a third of the monthly price increase. But for the Fed, the most worrisome aspect of August’s inflation report is likely the evidence that inflation has spread beyond the pump. When stripping out food and energy costs, so-called core inflation rose 2.4% in the 12 months ending in August, down from 2.5% in July. On a monthly basis, core rose 0.3%. After the release of Friday’s report, traders boosted the odds of a rate hike to 90% from 70% the day before, according to CME FedWatch. Central bank officials convene on Tuesday and Wednesday next week to determine their next move on interest rates. The prospect of higher inflation is also weighing on Americans’ attitudes toward the economy. The University of Michigan’s consumer sentiment survey showed a sharp 7.5% drop early this month, marking the second-lowest reading recorded since the inception of the gauge more than 70 years ago. Sentiment throughout this year has languished at unusually low levels, below anything seen during the Great Recession, 9/11 and foreign wars. “With a resurgence in fuel prices and trade tensions, consumers anticipate greater pressures on their pocketbooks to come,” Joanne Hsu, the surveys director, said Friday in a release. The Fed’s dilemma Fed Chairman Kevin Warsh, who has been reluctant to broadcast his views on interest rate decisions in advance of monetary policy meetings, has hinted at the possibility of a rate increase. If inflation isn’t showing signs of improvement, central bankers will “have work to do,” he said at the Fed’s annual Jackson Hole conference last month. Some of Warsh’s colleagues, however, have been more forceful about the need to act sooner rather than later. Fed Governor Christopher Waller said in a speech earlier this month that he would consider hiking rates at next week’s meeting if the August inflation data didn’t show signs of improvement. “It may not take much acceleration in inflation to nudge me into supporting tighter policy,” he said. Tighter monetary policy typically implies having higher interest rates aimed at reining in inflation or preventing it from worsening. At the same time, interest rate changes take time to work their way through the economy. By some estimates, the full effects can take one to two years to materialize. That means Fed officials have to make decisions based not just on where the economy is today, but on where they expect it to be months from now. Waiting too long to act can mean missing the window for a rate change to have its intended effect. Oil prices are continuing to climb, with diesel prices hitting a record $6 a gallon Friday, and the war with Iran shows little sign of ending anytime soon. With inflation expected to worsen as a result, even the small upticks in the latest data carry outsized weight for the Fed. And while much of the inflation Americans are experiencing is being driven by factors largely beyond the Fed’s control – namely the surge in oil prices and semiconductor shortages – a rate hike could help prevent those initial shocks from triggering broader, more persistent price increases. “The breadth of the price pressures makes the report especially difficult to dismiss. This is not simply an energy story; underlying inflation remains elevated across a wide range of categories,” Olu Sonola, head of US economics at Fitch Ratings, said in a note on Friday. In his view, the report cements the case for a hike. But Mike Skordeles, head of US economics at Truist Advisory Services, told CNN he’s not convinced a hike is necessary or productive. “The combination of higher energy prices and higher rates could slow the economy much more than a casual ‘tap on the brakes’ that a quarter-point rate hike would imply,” he said, particularly since job growth has been inconsistent. While last month’s 162,000 gain well exceeded economists’ expectations, in July and June employers hired a combined 52,000 workers. Inflation beyond the pump Some of the largest price increases in the August CPI report stemmed from tech. Computer software and accessory prices rose 25.4% for the 12 months ended in August, the largest annual price increase recorded. Computers and smart home assistants cost 8.4% compared to a year ago. Meanwhile, smartphone prices were down 12.2% versus the prior year. Earlier this week, though, in addition to announcing its new line of iPhones, Apple said it was raising prices of older models by $100. The price increases are tied to surging costs of producing chips, a byproduct of the booming demand of AI. There were also strong gains in prices of rental cars, vehicle maintenance, day care and preschool, nursing homes and in-home care. The rising cost of eldercare and childcare is tied to shortages of immigrant workers, who make up a large part of the so-called “care economy,” said Diane Swonk, chief economist at KPMG Economics. “Some 330,000 Haitians lost their Temporary Protected Status at the end of July; about 200,000 were workers. More than half were estimated to be working in the care economy,” Swonk wrote in a note Friday. Corporate America has a ‘cover’ Unlike individuals, big corporations often negotiate longer-term contracts with carriers that lock in their transportation rates, shielding them from some of the immediate impact when fuel and other transportation costs rise. For instance, General Mills CEO Jeffrey Harmening said Wednesday that the company is seeing overarching transportation costs, which he referred to as “logistics costs,” up 40% from this time last year. “But that’s a spot rate, and we don’t pay the spot rate on all of our freight. We probably pay the spot rate on probably about 7% of our freight,” he said at a Barclays investor conference. Spot rates refer to current market prices. He said the company’s key input costs, including wheat, are “covered” for the next six to nine months. In other words, General Mills can wait longer to pass along higher prices to consumers since it is currently shielded from much of the increased cost themselves. Temporary relief is also stemming from tariff refunds. Tractor Supply CEO Hal Lawton said his company is putting two-thirds of its anticipated tariff refund of $100 million to $150 million toward “covering freight and incremental fuel costs,” he said at the same Barclays conference. The other third has gone toward keeping prices lower than they otherwise would’ve been. But that relief may not last. Several CEOs have warned investors that the benefit of tariff refunds will fade, potentially leaving companies with fewer options in terms of absorbing rising costs.