U.S. CPI inflation persists in July

U.S. CPI inflation persists in July

*The CPI rose 0.5% in July, lifting the yr/yr rise to 5.4% while the core CPI excluding food and energy moderated to a 0.4% rise and 4.2% increase yr/yr (Chart 1). While moderation of the monthly increase in core inflation in July is welcome, inflation has increased far above earlier forecasts of the Federal Reserve and private forecasters—it is higher than any time since 19900–and its six-month annualized increase shows acceleration (Chart 2). And the inflation story is not over yet.

*CPI inflation measured yr/yr is poised to remain high or accelerate at least through year-end 2021. Even moderate monthly increases are expected to exceed the modest monthly increases in the CPI in the last five months of 2020 (the average monthly rise was 0.23% on headline and 0.16% on the core measure), which will raise the yr/yr increase. Most importantly, if aggregate demand in the economy remains strong, as we expect, production costs will continue to rise, and businesses will have flexibility to raise product prices.

*Prices of food and energy, which are excluded from the calculation of core consumer inflation, continued to rise rapidly. Food prices rose 0.7% in July, lifting its yr/yr rise to 3.4%, while rising prices of oil and natural gas through July generated another outsized monthly increase in energy (+1.6%), resulting in a 23.6% yr/yr rise. The recent sharp decline in oil prices and flat natural gas prices will contribute to declines in overall energy prices in coming monthly CPI reports.

*The moderation in the monthly rise in the core CPI was driven by a flattening of used car prices (+0.2%), apparel (unchanged), and transportation services (-1.1%), while shelter, the largest component of the CPI, rose 0.4% for the fourth consecutive month. This shelter component of the CPI, which comprises estimates of rent of primary residence and owners’ equivalent rent of residences, is expected to accelerate in the next year in lagged response to soaring home values (Chart 3).

*While some of the sharp rise in inflation reflects supply chain bottlenecks that are expected to unwind over time, underlying inflation pressures are mounting, driven by excessive monetary and fiscal stimulus that are generating excess demand. Stimulus policies affect economic activity with varying lags. Monetary policy remains aggressively stimulative, with zero rates and a bloated balance sheet that has provided excess liquidity. A sizable portion of recent fiscal legislation has not yet been spent, and Congress is on the verge of passing legislation that will provide more stimulus. Even as supply constraints dissipate, if these monetary and fiscal policies actually stimulate aggregate demand as they are supposed to, inflation pressures will persist.

Chart 1: Headline and Core CPI

Chart 2: Core CPI (6-month annualized and yr/yr change)

Chart 3: CPI – Shelter

Mickey Levy, mickey.levy@berenberg-us.com

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