Slower consumer price growth expected in August as investors hope for interest rate cut in September

On Wednesday, investors will process one of the most important data points that will influence the Federal Reserve's future interest rate policy: the consumer price index (CPI) for August.

The report, due out at 8:30 a.m. ET, is expected to show inflation at 2.5%, a slowdown from the 2.9% annual price increase in July. Compared to the previous month, consumer prices are expected to have increased 0.2%, matching the monthly increase in July.

On a “core” basis, which excludes the more volatile costs of food and gasoline, prices are expected to have risen 3.2 percent in August from a year earlier, unchanged from July's increase. Economists also expect monthly core price increases to remain unchanged, expecting a 0.2 percent increase, according to Bloomberg data.

Inflation has moderated but is above the Federal Reserve's 2% annualized target, but recent economic data, including a weakening labor market, suggest a rate cut is almost certain by the end of the Fed's next meeting on September 18.

“It is time to adjust policy,” Fed Chairman Jerome Powell said last month at the Kansas City Fed’s annual economic symposium in Jackson Hole, Wyoming.

The question now is how much the Fed will adjust its policy in terms of interest rate cuts. Wednesday's inflation report could help clarify this decision.

“We expect the August CPI report to continue to bring good news on inflation,” Bank of America economists Stephen Juneau and Jeseo Park wrote in a preview ahead of the report. “The data should strengthen the case for a cut in September.”

Read more: Fed forecasts for 2024: What experts say about the possibility of a rate cut

Core inflation has remained stubbornly high due to higher costs for housing and basic services such as insurance and healthcare. Bank of America expects these trends to remain largely unchanged.

“We continue to expect a divergence between core goods and services prices,” the economists said. “This is largely due to the stubbornness of rent inflation, which surprised on the upside last month. Over the medium term, rent inflation should normalize to pre-pandemic levels given supply growth and data on asking rents, but monthly data may remain mixed.”

Read more: What is inflation and how does it affect you?

The Goldman Sachs team led by economist Jan Hatzius expects residential property inflation to ease in August.

“For the rest of the year, we expect monthly core CPI inflation to be around 0.2%,” Goldman said. “We expect further disinflation in 2024 from a rebalancing of the auto, housing rental and labor markets, but expect this to be offset by catch-up inflation in health care and auto insurance.”

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“We forecast core consumer price index (CPI) inflation of 2.9% and core PCE inflation of 2.6% year-on-year in December 2024.”

25 or 50 basis points?

The debate about a 25 or 50 basis point rate cut has gained momentum in recent months as inflation continues to ease.

“Another favorable CPI report could give FOMC members enough 'confidence' that inflation is heading back toward 2% on a sustainable basis to support a 50 basis point rate cut,” Wells Fargo's economics team led by Jay Bryson wrote in a note to clients on Friday. “On the other hand, if the inflation data is better than expected, the consensus will likely agree on a 25 basis point cut on September 18.”

On Tuesday, markets were expecting a nearly 100 percent chance that the Federal Reserve will cut interest rates by the end of its September meeting. However, the odds of a 50 basis point cut versus a 25 basis point cut were split 70/30, after traders last week estimated a roughly 60/40 chance, according to the CME FedWatch tool.

However, the Fed's decision will not depend on inflation alone, as the US economy created fewer new jobs than expected in August.

“After the first cut, we believe activity and labor market data will be a more important factor in the pace and depth of the cut cycle than inflation,” said Juneau and Park of Bank of America. “In other words, the Fed's reaction function begins to place more emphasis on its other mandate – maximum employment.”

Alexandra Canal is a senior reporter at Yahoo Finance. Follow her on X @allie_canal, LinkedIn, and send her an email at [email protected].

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