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US consumer price index triggers discussion about interest rate cut after surprising downward trend

US consumer price index triggers discussion about interest rate cut after surprising downward trend

The US consumer price index fell short of expectations in June, rising 3% year-on-year, reigniting discussions about interest rate cuts by the Fed.

The results follow a negative surprise in May, when annual growth was 3.3% instead of the expected 3.4%, and a drop in inflation to 3.4% in April from 3.5% in March. In June, the consumer price index fell by 0.1%.

In the Federal Reserve’s latest decision on June 12, Jerome Powell announced that interest rates would remain in the range of 5.25 to 5.5 percent and reiterated that these rates would be maintained until inflation moves “sustainably” toward 2 percent.

But Lindsay James, investment strategist at Quilter Investors, believes this month’s numbers “give the Fed enough room to maneuver” to begin cutting interest rates.

“As in other developed markets, services sector inflation remains somewhat higher than many would like, but we are seeing goods sector inflation coming back down sufficiently to offset this and bring down overall inflation levels,” James said.

“In testimony before Congress this week, Fed Chairman Jerome Powell sought to refute the notion of cutting interest rates sooner rather than later, but also acknowledged the risk of a sharp deterioration in labor markets if the Fed keeps rates too high for too long.

“The employment situation in the US is starting to weaken and economic growth is now definitely being affected. Of course, you have to take the presidential election into account and given the volatility that this can bring, it might be better to get the first rate cut done long before interest rates start to rise feverishly.”

See also: Inflation in the UK falls to 2% target

Seema Shah, chief global asset management strategist at Principal, agreed that the path was clear for a rate cut in September, but said a July cut was “off the table.”

“Not only would this raise questions like, ‘What do they know about the economy that we don’t?’, but the Fed will need to gather additional evidence of easing price pressures to be absolutely certain about the path of inflation,” Shah said.

“However, by September they will likely produce a series of data supporting a rate cut. For now, the combination of solid labor market data and easing inflation is consistently positive for equities.”

Daniel Casali, chief investment strategist at asset manager Evelyn Partners, agreed that a September rate cut was likely, but said July was also possible if inflation eased. Casali cited stabilized consumer inflation expectations and a strong dollar as well as the remaining after-effects of Covid as reasons for a slowdown.

“The disruptions caused by the pandemic and policy easing are still unraveling. This is reflected in a slowdown in housing inflation, where supply and demand dynamics were distorted during Covid,” Casali said.

“If inflation in the consumer price index (CPI), which accounts for about 40% of underlying core inflation, continues to slow, this could be seen as confirmation that this trend is intact. Indeed, the consumer price index slowed to 5.2% in June, its lowest level in about two years, and is below its cyclical peak of 8.2% in March 2023.”

He added: “The main risk to this favorable outlook is a surprise rise in energy prices and the fact that workers are receiving higher wages at a time of full employment. Companies could then pass these labor costs on to consumers in the form of higher prices. This could keep inflation higher than the Fed would like and undermine future rate cuts that the market expects.”