Inflation falls to 2.9% in July, the lowest level in two years

July saw a moderation in inflation rates, with the annual inflation rate decelerating to 2.9%, a figure last seen in early 2021, according to the latest data from the Labor Department. This slowdown is in line with expectations and is largely attributed to rising housing costs, which suggests a potential reduction in interest rates by September.

The Consumer Price Index (CPI), which measures the average change over time in prices paid by urban consumers for a basket of consumer goods and services, rose 0.2% in July. This increase brought the annual increase to 2.9%, slightly below the 3.0% forecast by Dow Jones economists.

Isolating the main components, which exclude volatile food and energy prices, the headline CPI also posted a 0.2% monthly increase and a 3.2% annual increase, meeting expectations set by analysts. Notably, the annual headline inflation rate marked its lowest since April 2021, as reported by the Bureau of Labor Statistics.

The main driver behind the overall increase was a 0.4% increase in housing costs, which contributed nearly 90% of the total increase in the consumer price index. Meanwhile, food prices saw a modest 0.2% increase and energy prices were flat.

Financial markets reacted with mixed signals following the report, with stock futures falling slightly and Treasury yields rising across the board.

Despite the low food inflation, some items such as eggs saw significant price increases of up to 5.5%. In contrast, prices of cereals and bakery products fell by 0.5%, while dairy products fell by 0.2%.

The gradual return of inflation toward the Federal Reserve’s 2% target was further underscored by an earlier report on producer prices, which pointed to a slight increase of 0.1% in July and a 2.2% increase on an annual basis.

Federal Reserve officials appear poised to begin rate cuts, reflecting a cautious approach to adjusting monetary policy. Market expectations now lean toward a likely quarter-percentage point cut at the Fed’s next meeting on September 17-18, with further reductions anticipated through the end of 2024.

Seema Shah, chief global strategist at Principal Asset Management, commented on the implications of the CPI data, suggesting that while inflation easing removes some headwinds for the Fed, it does not require an aggressive 50 basis point cut at this time.

The report also highlighted persistent inflation in some sectors despite the overall slowdown. In particular, auto insurance costs rose 1.2% and rental income expectations among homeowners rose, both indicators of ongoing price pressures.

Conversely, several sectors, including medical services, clothing and essential goods, saw price declines, demonstrating the uneven nature of inflation trends.

This nuanced inflation picture calls for continued scrutiny of both inflationary pressures and employment statistics, as noted by Liz Ann Sonders, chief investment strategist at Charles Schwab.