U.S. inflation in August fell to its lowest level since February 2021, according to a Labor Department report released Wednesday, while a key measure of inflation came in higher than expected. This combination has set the stage for a likely quarter percentage point interest rate cut from the Federal Reserve.
The consumer price index (CPI), which tracks the cost of a broad range of goods and services across the U.S., increased by 0.2% for the month, matching expectations based on the Dow Jones consensus. The 12-month inflation rate now stands at 2.5%, down from 2.9% in July and slightly below the 2.6% forecast. This marks the lowest inflation rate in three and a half years.
However, the core CPI, which strips out volatile food and energy prices, increased by 0.3% for the month, slightly higher than the 0.2% predicted. Over the past year, core inflation remained steady at 3.2%, in line with forecasts. The rise in core CPI indicates that the Federal Reserve is still cautious about inflation, making a larger interest rate cut unlikely when policymakers meet next week.
Following the release of the report, U.S. stocks initially dipped, and Treasury yields showed mixed movements. However, the market rebounded later in the day, with major stock averages recovering their losses.
In the federal funds futures market, traders now estimate an 85% chance that the Federal Open Market Committee (FOMC) will approve a 25 basis point (0.25%) rate reduction when it concludes its meeting on September 18. This is a shift from a month ago when traders were leaning toward a larger 50 basis point cut.
Despite the overall moderation in inflation, housing-related costs remain a significant issue. The shelter component of the CPI, which accounts for about one-third of the index, rose by 0.5%, representing approximately 70% of the core inflation increase. Shelter costs have risen by 5.2% over the past year.
Food prices rose slightly, up 0.1%, while energy costs decreased by 0.8%. The report also noted a 1% drop in used vehicle prices, a 0.1% decline in medical care services, and a 0.3% rise in apparel prices. Notably, egg prices jumped 4.8%.
Real earnings increased in August, with average hourly earnings outpacing inflation by 0.2%, according to a separate release from the Bureau of Labor Statistics. Over the past year, inflation-adjusted average hourly earnings have risen by 1.3%.
The Federal Reserve is also focusing on a slowing labor market. Since April, job creation has halved compared to the preceding five months. Fed officials are now balancing concerns about inflation with the need to prevent a broader economic slowdown.
Regardless of the Fed's decision next week, financial markets are already anticipating lower interest rates. Treasury yields, especially for two- and ten-year bonds, are at their lowest in more than a year. The yield curve, which had been inverted—often a signal of recession—has recently reversed, suggesting that both interest rate cuts and an economic slowdown may be on the horizon.
While Wednesday's report provided more evidence that inflation is easing, it remains above the Fed’s 2% target. Certain categories saw price increases, including airline fares, which rose by 3.9% in August after five months of declines. Motor vehicle insurance also continued its upward trend, climbing 0.6%, bringing the year-over-year increase to 16.5%. Hospital services costs increased by 0.4% and have risen 5.8% over the past year.
On the other hand, declining energy prices have helped reduce inflation. Gasoline prices dropped by 0.6% in August and are down 10.3% from a year ago, contributing to a 4% overall drop in the energy index, which includes a 12.1% decrease in fuel oil prices.