Key Takeaways

  • Data released by the U.S. Department of Labor on Wednesday showed that the Consumer Price Index (CPI) rose 2.5% year-over-year in August, down from 2.9% in July, marking the slowest pace in over three years. This data almost ensures that the Federal Reserve will lower borrowing costs next week.
  • Housing costs were the biggest driver of inflation in August, rising 0.5% month-over-month. Energy prices fell 0.8% month-over-month, with fuel oil prices down 1.9% and energy services prices down 0.3%. Excluding volatile food and energy prices, core CPI rose 0.3% month-over-month and 3.2% year-over-year, slightly above July's level.
  • "Softer demand for goods and services due to heightened consumer price sensitivity, narrower corporate markups, moderate wage growth, and slowing rent inflation will continue to provide healthy disinflationary momentum in 2025," said Lydia Boussour, senior economist at EY, in an email. EY expects the Federal Reserve to implement three 25-basis-point rate cuts in the remainder of 2024, with cumulative cuts of 1.25 percentage points in 2025.

Deep Dive

The persistence of housing cost inflation is a key focus for the market. In the 12 months through August, housing costs rose 5.2%. This data prompted interest rate futures traders to lower their expectations for a 50-basis-point rate cut by the Federal Reserve at its September 18 meeting.

According todata from the CME FedWatch tool, traders on Wednesday saw only a 15% probability of a 50-basis-point rate cut by the Fed next week, down from 34% on Tuesday. They saw an 85% probability of a 25-basis-point cut (lowering the federal funds rate from its current range of 5.25% to 5.5%).

"While the disinflationary trend remains intact, volatility in services prices could provide ammunition for less dovish policymakers to push for a methodical approach to rate cuts," Boussour said.

Since mid-2023, inflation has gradually moved back toward the Fed's 2% target. Excluding housing prices, transportation services and apparel prices also rose 0.9% and 0.3% month-over-month in August, respectively.

"It is too early to declare victory over inflation," Bank of America economists said in a Wednesday report, pointing to persistent owners' equivalent rent inflation. "We believe the Fed cannot let its guard down on inflation. Therefore, a methodical easing cycle (25 basis points per meeting) seems the most prudent path at this point."

Strong wage growth could bring some price pressures, Dana Peterson, chief economist at The Conference Board, said during a Wednesday webcast. The organization said Monday that companies plan to increase their salary budgets by 3.9% next year, a near-record increase driven by reduced labor supply.

The increase in salary budgets, while lower than the 4.4% in 2023, will exceed this year's 3.8%, according to The Conference Board. The data is based on a survey of 300 "compensation leaders" regarding base pay plans.

"We are still seeing significant increases in wages and benefits, and these costs will be passed on," Peterson said. She predicts inflation will not return to the Fed's target level until mid-2025. "There is also a risk of reaching the target earlier," she said. "That would certainly be good, but the Fed needs to keep inflation at that level."

Consumer expectations for inflation are a trend closely monitored by policymakers. A survey released Monday by the New York Fed showed thatconsumer inflation expectations remained broadly stable last month。

New York Fed data showed that consumers' median inflation expectations for one year and five years ahead held steady at 3% and 2.8%, respectively. The median expectation for inflation three years ahead was 2.5%, up 0.2 percentage points from July.