US inflation bounces marginally to 3.2% in July 2023

14 Aug 2023 , 10:05 AM

From a low of 3% consumer inflation in June 2023, the headline inflation in the US for July 2023 bounced marginally by 20 bps to 3.20%. In June 2023, when the US inflation had touched 3%, it had also touched a 28-month low. However, the US Federal Reserve will take comfort from the fact that the headline inflation still remains well below the 4% mark. As of July 2023, consumer inflation in the US is still 590 basis points lower than the peak of 9.1% in June 2022. However, short term pressures continue to be evident with the MOM (month-on-month) inflation in July 2023 steady at a level of 0.2%. Would this latest data point influence the Fed action going ahead?

Here it would be instructive to look back at the interest rate journey of the Fed in the recent past. The Fed had paused on its rate hike journey in June 2023, but in late July, it had once again raised its benchmark Fed rates by 25 bps. Obviously, even the sharp fall in inflation had not induced the Fed to pause in the July 26, 2023 policy too. Even when the Fed had paused in June 2023, the members had underlined the strong possibility of 2 to 3 more rate hikes. However, the Fed continues to remaining focused on bringing inflation to the 2% mark. Between March 2022 and August 2023, the Fed has already raised rates by 525 basis points while consumer inflation has fallen by a full 590 bps from the peak levels of June 2022. The marginal bounce in inflation from 3.0% in June 2023 to 3.2% in July 2023 raises questions about the future trajectory of interest rates. Ahead of the July inflation count, there were strong expectations that rates had topped out, but now we have to wait and watch how the Fed reacts to this small bounce in consumer inflation for July 2023.

US consumer inflation continues to remain progressive lower

The overall fall in US inflation from the peak in June 2022 is still quite impressive at 590 bps in response to a 525 bps spike in interest rates. That looks like a good deal for the Fed and also a good reason for the Fed members to pause now. However, that would still depend on the whether the Fed members think that the lag effect of rate hikes can do the job or they still need to actively set the agenda. The glide path of inflation is still impressive with inflation progressively lower, except for the small exception in July 2023. US consumer inflation had peaked at 9.1% in June 2022. Since then, it has reduced progressively to 8.5%, 8.4%, 8.2%, 7.7%, 7.1%, 6.5%, 6.4%, 6.0%, 5.0%, 4.9%, 4.0%, and 3.0% between July 2022 and June 2023. The month of July 2023 saw a marginal bounce in consumer inflation to 3.2%. If one looks at the break-up of consumer inflation in July 2023, food inflation is sharply lower by another 80 bps while core inflation has fallen by 10 bps. However, pressure has come from the fuel inflation, where the contraction has reduced sharply in July 2023.

Energy inflation which had dipped into negative in March 2023, has remained in the negative since then. However, in July 2023, the contraction in fuel inflation reduced from -16.7% to -12.5% and. That explains the slight 20 bps bounce in consumer inflation in July 2023. The Fed had been continuously worried about core inflation at above 5%, but that has now fallen below the 5% mark. The big challenge for the Fed would be to get core inflation to below 4%, as it continues to remain sticky at 4.7% in July 2023. Till now, the Fed has managed to contain inflation without hitting growth. However, that could get increasingly difficult going ahead.

Food inflation lower, core inflation flat, energy prices harden MOM

Even as the impact of the 525 bps Fed rate hike is evident in the form of 590 bps fall in inflation, Fed has not ruled out more rate hikes, if necessary. After the pause in June 2023, the Fed again hiked rates by 25 bps in July. The question is; what is the terminal rate target?

Inflation Basket Category	Jul 2023 (YOY)	Jun 2023 (YOY)	Inflation Basket Category	Jul 2023 (YOY)	Jun 2023 (YOY)
Food Inflation	4.90%	5.70%	Core Inflation	4.70%	4.80%
Food at home	3.60%	4.70%	Commodities less food and energy	0.80%	1.30%
Cereals and bakery products	7.00%	8.80%	Apparel	3.20%	3.10%
Meats, poultry, fish, and eggs	-0.20%	-0.20%	New vehicles	3.50%	4.10%
Dairy and related products	1.30%	2.70%	Used cars and trucks	-5.60%	-5.20%
Fruits and vegetables	2.90%	3.00%	Medical care commodities	4.10%	4.20%
Non-alcoholic beverages	5.40%	7.60%	Alcoholic beverages	4.10%	4.40%
Other food at home	5.40%	7.10%	Tobacco and smoking products	6.10%	5.80%
Food away from home	7.10%	7.70%	Services less energy services	6.10%	6.20%
Full service meals and snacks	5.80%	6.20%	Shelter	7.70%	7.80%
Limited service meals	7.10%	7.80%	Rent of primary residence	8.80%	8.30%
Energy Inflation	-12.50%	-16.70%	Owners’ equivalent rent	7.70%	7.80%
Energy commodities	-20.30%	-26.80%	Medical Care Services	-1.50%	-0.80%
Fuel oil	-26.50%	-36.60%	Physician Services	0.40%	0.50%
Gasoline (all types)	-19.90%	-26.50%	Hospital Services	3.10%	4.10%
Energy services	-1.10%	-0.90%	Transport Services	9.00%	8.20%
Electricity	3.00%	5.40%	Motor vehicle Maintenance	12.70%	12.70%
Natural gas (piped)	-13.70%	-18.60%	Motor vehicle insurance	17.80%	16.90%
Headline Consumer Inflation	3.20%	3.00%	Airline Fare	-18.60%	-18.90%

Data Source: US Bureau of Labour Statistics

Here are some takeaways.  Firstly, food inflation has fallen across the board on a yoy basis, especially in the cereals and dairy products basket. Under energy category, energy products and commodities remain in the negative, albeit to a lesser extent due to the waning of the base effect. However, the impact of electricity continues to be negative on overall consumer inflation. Core inflation has eased by just 10 bps to 4.70%, although most of the pressure is coming from rentals, which continue to remain high. However, economists are of the considered view that the core inflation needs to tend to well below the 4% mark if the headline inflation target of 3% has to be met on a sustained basis. 

MOM inflation stays flat at 0.2% in July 2023

The US Bureau of Labour Statistics (BLS) reports inflation on yoy basis, as well as on MOM high frequency basis. After touching a high of 1.2% in June 2022, MOM inflation stayed below 1% all through. In April 2023, MOM inflation was back at 0.4%, but May 2023 again saw MOM inflation softening back to 0.1%. June saw MOM inflation higher at 0.2%, and the July MOM inflation has stayed at the same level.

Here are some of the key takeaways from the MOM inflation data for July 2023.

1. MOM food inflation in July 2023 bounced to 0.2% compared to Jun 2023. Total of 4 out of the 6 store food categories saw higher inflation viz. meat, poultry, fish, and eggs.

    

2. Energy index rose 0.1% MOM in July 2023 as gasoline prices jumped 0.2%. Downward pressure is seen coming in from electricity pressure.

    

3. Core inflation growth was flat at 0.2% MOM in July 2023.  The pressure comes from the shelter index rising 0.4% and index for rent also rising by 0.4% in July 2023.

RBI may have to balance prices and flows now

How would the RBI and the Indian economy react to the latest inflation data? The 25 bps hike in July has certainly upset calculations and India would be hoping that the Fed now maintains status quo on rates. But, as we have seen in the past, hope can be a good breakfast, but a bad supper. India must have its action plan and that back-up plan is that the RBI would be ready to hike rates if the situation called for. By maintaining rates static at 6.5% since February 2023, the RBI certainly has some leeway on hand to hike rates, should the need arise. Even the markets are now pencilling in 50% probability of a 25 bps rate hike by the RBI in the October policy statement. That could be very possible. 

For the RBI, the US Fed decision to hike rates in July by 25 bps did create a dilemma, although it would heave a sigh of relief from the slight bounce in US inflation to 3.2%. However, India would be more worried about the impact that erratic inflation would have had on Indian inflation . In May, India’s consumer inflation had touched 4.25%, just 25 bps short of the target of 4%. However, in June 2023, the consumer inflation had bounced back to 4.81% in India and the inflation in July and August are expected to veer closer to 6%, largely driven by food inflation and fuel inflation. The next big item for the RBI to focus on would be the India CPI inflation that would be announced next week.

FPI flows into India have slowed in August after the deluge of May, June, and July 2023. FPIs appear to have applauded the RBI decision to pause twice, with $17 billion of FPI inflows in 3 months. However, that enthusiasm has not sustained in August, although that could be attributed more to the unexpected downgrade of US debt by Fitch. With the Fed announcing a rate hike of 25 bps in July 2023, and poised for more, RBI would have to keep its Plan-B in place. Rising rates in the US amidst low inflation and static rates in India amidst rising inflation; is not a very healthy combination. The RBI is, obviously, conscious of the risks of such a dichotomy and its implications on foreign flows.