The headline consumer price index (CPI) ticked up 0.1% in July, slightly below market expectations. Inflation on a year-on-year basis remained steady at 1.7% in July.

Core inflation matched headline in July, with a slight 0.1% increase for the fourth month in a row now, slightly disappointing market expectations for a 0.2% gain. That left core inflation at 1.7% year-on-year, a pace that has been steady for three months now.

Delving into the details, a slight drop in energy prices on the month (-0.1%) offset a 0.2% m/m increase in food prices, leaving headline inflation matching core. Prices also rose for shelter (+0.1% m/m) , medical care (+0.3% m/m), recreation (+0.3% m/m), apparel(+0.3% m/m), motor vehicle insurance(+0.3% m/m) and airline fares (+0.7% m/m) all rose in July.

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These increase were somewhat offset by declines in prices for new vehicles (-0.5% m/m), communication (-0.2% m/m), used cars & trucks (-0.5% m/m) and household furnishings and operations (-0.2% m/m).

Overall the tug of war in core inflation between falling goods prices (-0.1%) and rising services prices (+0.2%) continued in July. That dynamic has been in place since 2014, exacerbated by a strong U.S. dollar. Now, the services side of the rope is losing some strength. Core services inflation was 2.5% y/y in July, a notable cooling from the 3.2% pace in Q3 2016. Meanwhile core goods prices are in deflationary territory, down 0.6% from a year ago, a pace that has been reasonably steady over the past year.

Key Implications

The story remained the same for the American economy in July. A healthy job market, but no new momentum in inflation pressures. While one-off price drops in specific categories are part of the story, it doesn’t explain the entire weakening seen in measures of inflation that strip out such volatility (trimmed mean or median CPI). Inflation has weakened across many advanced economies, suggesting that a broader phenomenon – such as persistent economic slack globally – may be playing a role.

We still expect inflation pressures to build through the remainder of the year, but the process is proving slower than expected This adds considerable risk to the pace of Fed hikes over the rest of this year and in 2018.

That said, it is unlikely today’s inflation data will keep the Fed from starting the process to normalize its balance sheet in September. Recent Fed speakers, even some notable doves like Kashkari, have emphasized that normalization of the balance sheet is coming soon.


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