US inflation falls to 2.9% in July

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US inflation fell to 2.9% in July, strengthening the case for the Federal Reserve to cut interest rates at its next meeting in September.

The annual increase in the consumer price index was only 0.1 percentage point lower than in June, beating economists' expectations that the figure would remain stable at 3%.

It is also the first time since March 2021 that the headline CPI has fallen below 3%.

The core CPI, which excludes volatile food and energy prices, rose 3.2%, down from 3.3% in June, according to data released Wednesday by the Bureau of Labor Statistics.

The latest figures raise hopes that the Fed is succeeding in easing price pressures and will be welcomed by the White House. American voters' concern about inflation has been a stumbling block for Democrats in this year's presidential campaign.

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Overall, I find [the data] “It’s encouraging,” said David Kelly, chief global strategist at JPMorgan Asset Management, adding that it should give the Fed additional confidence that price pressures are moving toward its 2% target.

Fed officials have been looking for more evidence that inflation is slowing sustainably before cutting borrowing costs as Americans show signs of reining in their spending.

But a sharp drop in jobs growth earlier this month stoked fears that the central bank waited too long to cut rates, and triggered a wave of turbulence in U.S. financial markets last week.

“I think the Fed has shifted its focus from inflation to employment,” said Tom Porcelli, chief U.S. economist at PGIM Fixed Income, referring to the focus central banks have placed on determining when to cut borrowing costs. And this report will only reinforce that shift, I think.

Kelly added that the August jobs report, which will be released in early September, will be the most important of the year.

Ahead of the data release, investors were split over whether the central bank would cut borrowing costs by a quarter or half a percentage point at its next policy meeting in September.

After the figures were released, futures markets moved slightly in favor of a more modest decline. Investors continued to expect a one percentage point decline by the end of the year.

Ultimately, that keeps the Fed on track for a 25 basis point rate cut in September, said Dean Maki, chief economist at Point72. I think for the Fed to cut rates by 50 basis points in September, there would have to be further weakening in the labor market.

U.S. stocks posted their first five-day rally in more than a month on Wednesday. The benchmark S&P 500 index closed up 0.4%, while the tech-heavy Nasdaq gained 0.03%.

Those modest gains were enough to push both indices back to levels last seen before last week's market rout, triggered by fears of a possible U.S. recession that would require much deeper rate cuts.

Those fears have eased somewhat, with interest rate futures signaling a 36% chance of a half-point cut in September, down from 69% a week ago, according to CME Group's FedWatch tool.

The latest data comes after the Fed quickly raised interest rates to combat inflation that hit multi-decade highs in 2022 due to supply bottlenecks and a surge in demand following the Covid-19 pandemic.

The U.S. central bank has been holding rates at a 23-year high of between 5.25 and 5.5 percent for more than a year.

According to the BLS, higher housing expenses accounted for nearly 90% of the 0.2% monthly increase in the CPI. It also helped push services inflation up to 0.3% for the month.

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The energy index was unchanged in July, after two consecutive months of decline, and costs related to airline tickets, clothing and used vehicles helped moderate the overall inflation rate.

US President Joe Biden said on Wednesday that the latest figures showed we were continuing to make progress in combating inflation and reducing costs for American households.

The U.S. jobs market grew more slowly than expected in July, according to data released earlier this month. The unemployment rate has also risen for four straight months, to 4.3%, raising concerns that the economy is weakening.

Some economists have warned that if the central bank does not quickly and drastically cut borrowing costs, it risks triggering a deeper economic contraction.

Fed Chairman Jay Powell has said inflation can return to the central bank's 2% target without a recession.

He also said the Fed would respond if the labor market were to weaken unexpectedly or if inflation were to fall faster than expected.

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