Lower oil prices pulls down July 2022 US consumer inflation to 8.5%

11 Aug 2022 , 07:40 AM

The YOY inflation came down by 60 bps in July 2022 to 8.50% compared to the 41-year high of 9.1% in June 2022. The pre-inflation surveys had already hinted at tapering of inflation and the first signals are evident in the July inflation figure.

US Consumer Inflation has been on a sharp uptrend as evinced in the chart below. The US economy had reported consumer inflation at 7.9% in February 2022, 8.5% in March 2022, 8.3% in April 2022, 8.6% in May 2022 and 9.1% in June 2022. For a change, the consumer inflation in July 2022 tapered by 60 bps to 8.5%, as an outcome of hawkish measures.

Chart Source: US Bureau of Labour Statistics

There were two diverse trends visible in the inflation basket in the month of July. The headline food inflation rose by 50 basis points from 10.40% in June to 10.90% in July 2022. However, this was more than offset by a sharp fall in the energy inflation, which fell by more than 800 basis points in July 2022 compared to the energy inflation levels in June. The sharp fall in energy inflation was largely driven by lower prices of fuel oil, gasoline and natural gas. In the food basket, it is the Food at Home category that experienced the biggest spike in inflation. Most of the nutrition essentials have seen higher prices. For a change, the core inflation (net of food and fuel) was static at 5.9% in July 2022.

Energy the show stopper; but food inflation the show spoiler

While headline consumer inflation may have fallen 60 bps from 9.1% to 8.5% yoy, the July 2022 inflation is still above the median inflation witnessed in the 3 months prior to June. There has been a sharp fall in crude oil prices globally and that is reflected in the 800+ bps fall in energy inflation in July. However this is a rather ephemeral gain to rely on, since Brent Crude has fallen below $100/bbl, purely on recession fears. In absolute terms, all the 3 components of the inflation basket are well above their 5 year median levels.

Category	July 2022 (YOY)	Category	July 2022 (YOY)
Food Inflation	10.90%	Core Inflation	5.90%
Food at home	13.10%	Commodities less food and energy	7.00%
·         Cereals and bakery products	15.00%	·         Apparel	5.10%
·         Meats, poultry, fish, and eggs	10.90%	·         New vehicles	10.40%
·         Dairy and related products	14.90%	·         Used cars and trucks	6.60%
·         Fruits and vegetables	9.30%	·         Medical care commodities	3.70%
·         Non-alcoholic beverages	13.80%	·         Alcoholic beverages	4.20%
·         Other food at home	15.80%	·         Tobacco and smoking products	7.70%
Food away from home	7.60%	Services less energy services	5.50%
·         Full service meals and snacks	8.90%	Shelter	5.70%
·         Limited service meals and snacks	7.20%	·         Rent of primary residence	6.30%
Energy Inflation	32.90%	·         Owners’ equivalent rent	5.80%
Energy commodities	44.90%	Medical Care Services	5.10%
·         Fuel oil	75.60%	·         Physician Services	0.80%
·         Gasoline (all types)	44.00%	·         Hospital Services	3.90%
Energy services	18.80%	Transport Services	9.20%
·         Electricity	15.20%	·         Motor vehicle Maintenance	8.10%
·         Natural gas (piped)	30.50%	·         Motor vehicle insurance	7.40%
Headline Consumer Inflation	8.50%	·         Airline Fare	27.70%

Data Source: US Bureau of Labour Statistics

There are two trends that emerge from the food basket analysis above. Food inflation, especially food at home, continued to surge and the overall spike of 50 bps in food inflation can be a cause for concern. Clearly, supply chain constraints are hitting the food basket hardest.

While energy inflation is sharply lower, most experts expect the retail gasoline prices in the US to again surge to record highs, pulling up energy inflation in coming months.

What did we read from high frequency inflation numbers?

The Bureau of Labour Statistics (BLS) reports US inflation on a yoy basis, as well as on a MOM high frequency basis. It looks at inflation for July 2022 over July 2021 and also over June 2022. The high frequency inflation has plummeted from a high of 1.3% in June 2022 to a yearly low of 0.0% in July 2022. But how does the overall basket look on a MOM basis?

Chart Source: US Bureau of Labour Statistics

MOM (high frequency) inflation has fallen from a high of 1.3% to a low of 0.0%, hinting at aggressive rate hikes delivering the goods for the Fed. However, even the MOM fall in inflation was largely due to energy prices.

a)      Food inflation remains a pain point. It spiked 1.1% MOM in July 2022, on top of a 1.0% spike in June 2022 and a 1.2% spike in May 2022. This is the seventh consecutive increase of 1% and above in food inflation.

b)      Energy inflation was down month-on-month by 4.5% in July 2022, reversing the trend of the last 2 months. While electricity was higher MOM, oil and gas prices fell sharply.

c)      The core inflation was up 0.3% in July 2022 on top of 0.7% in June and 0.6% in May 2022. Other than airline fares and apparel, all other items of core inflation are up MOM.

So, what does this mean for the Fed stance, in its remaining 3 FOMC meets in 2022?

Fed may go slow on rate hikes, but hawkishness stays

Since March 2022, Fed has hiked rates by 225 bps and brought the Fed rates to the neutral level of 2.25% to 2.50%. While the Fed will look to front-load most of the rate hikes in 2022, it will be a little more watchful and data-driven, now that the neutral rate has been reached. However, the fact remains that food inflation remains sticky and the headline inflation is still miles away from the Fed target of 2%.

However, the Fed has the luxury of more data points ahead of the September 2022 FOMC meet including updated numbers on GDP, jobs, headline inflation, productivity etc. The July productivity report shows that US wages were rising even as manufacturing productivity has been falling. That is hardly sustainable and the Fed would look at more hawkishness to correct this anomaly.  Hawkishness stays, but perhaps a bit toned down!

What does 8.5% US inflation mean for India?

There something similar about the Indian and the US economic situations. Both have hiked rates aggressively from post-COVID lows. However, in both cases the inflation has remained sticky. The other similarity is that both economies have reached the pre-COVID interest rate levels and from here on, any hawkishness will come at the cost of economic growth. However, the Indian economy still has the comfort of sharply higher GDP growth to savour.

What will the RBI do when it meets next in October 2022? If you read the language of the August policy, there are 2 things that emerge.

Firstly, RBI is taking a hard-nosed stance to cut inflation. Secondly, it is also attacking liquidity and one of the themes of recent policy announcements has been the winding up of accommodation. US inflation in July 2022 at 8.5% means that the Fed has a long hard battle on hand. Till then, the RBI has to stay on the same side to avoid the risk of monetary divergence. That surely has a cost!