Inflation Monitor: Blip or Turning Point?

Inflation data due this week will offer the first evidence of whether June's broad cooling was a one-off head fake or perhaps the start of a new trend.

Equity markets were relieved after data showed inflation slowed in June. Falling energy prices, led by gasoline, accounted for much of the deceleration. Still, the improvement was widespread enough to buy some time for the Federal Reserve, which stayed in wait-and-see mode by keeping interest rates unchanged at its July meeting.

But one month of data doesn't amount to a new downtrend, and inflation, which had been gaining steam in recent months, remains above the Fed's 2% target. Meanwhile, oil prices also remain unusually volatile due to the war in Iran, and upstream inflationary pressures are still elevated compared with a year earlier.

Here's what to know and look for as Consumer Price Index (CPI) and Producer Price Index (PPI) data for July come out August 12 and 13, respectively.

Though the June headline CPI fell 0.4% from a month earlier, core CPI was unchanged from the previous month, underscoring the degree to which the headline index's decline was driven by lower energy prices. That included a 9.7% drop in gasoline prices, which pushed the CPI energy index 5.7% lower from a month earlier.

But Fed policymakers can't count on lower oil prices for continued relief, and even if they could, other inflationary pressures offer plenty to worry about. The Fed's preferred inflation gauge, the Personal Consumption Expenditures (PCE) price index, fell 0.1% from a month earlier in June but rose 3.7% from a year earlier. The core PCE index, which excludes food and energy, rose 0.1% from the previous month and 3.3% from a year earlier, a slight deceleration from 3.4% in May.

Additional progress on inflation will likely depend at least in part on services prices. Though trending lower, services inflation has remained relatively high in the wake of the COVID-era inflation spike and had been gaining steam in the months leading up to the June reading.

In June, though, growth in services indexes slowed sharply. The PCE and CPI services indexes barely budged from a month earlier, rising 0.1% and 0%, respectively, in both cases the smallest increase in more than five years. The CPI services results can be attributed largely to rare and likely unsustainable price declines for car insurance, medical care, and hotels, and the cost of shelter rising only 0.1%, the slowest pace since 2021.

Still, despite those positive developments, PCE services, excluding energy and housing, rose 3.8% from a year earlier in June, so additional deceleration, or a continuation of only mild increases, is likely needed to help contain overall inflation.

While the headline PPI fell 0.3% in June from a month earlier, the biggest drop in 14 months, the move was driven primarily by a 6.4% decline in the cost of energy products. By contrast, the core PPI, which excludes food and energy, rose 0.2% from May and 4.7% from a year earlier, illustrating that when energy is excluded, upstream price pressures remain elevated.

Meanwhile, consumer demand is solid. Consumer spending rose 3.2% at an annual rate in the second quarter, according to gross domestic product data released two weeks ago.

Though PPI indexes are an unreliable indicator of consumer prices, they do flag price pressures on businesses, which will often pass along cost increases when they believe consumers will tolerate them. So, both PPI indexes and consumer spending data are worth watching for evidence of pass-through.