Inflation Trends and Monetary Policy

Investor focus was directed towards key U.S. inflation report on Thursday. Through a persistent series of interest rate hikes, the Federal Reserve has significantly reduced the escalation of consumer price levels from the substantial 9.1% observed in June 2022.

The monthly headline consumer price index (CPI) remained unchanged at 0.2%, in line with projections. On an annual basis, the index accelerated to 3.2%, surpassing June’s figure of 3.0%, but below estimates of 3.3%.

The monthly core CPI, which excludes volatile components such as food and energy, remained unchanged at 0.2%, while the annual figure rose by 4.7% below forecasts and June’s reading of 4.8%.

The predominant contributor to the monthly inflation surge was shelter costs, which rose 0.4% for the month and 7.7% from the previous year. Food prices experienced a 0.2% increase on a monthly basis, while energy prices saw a mere 0.1% uptick, despite notable surges in crude oil prices and corresponding pump prices.

Collectively, the latest dataset underscores that while inflation has receded from the peak levels observed in mid-2022, it still remains notably above the Federal Reserve’s target of 2% which makes near-term interest rate cuts unlikely.

While the direction of inflation is promising, its persistent elevation implies that the Federal Reserve has not done its job yet. The process of disinflation is expected to be somewhat challenging and may necessitate further economic adjustments before achieving a sustainable alignment with the 2% target.

Nevertheless, the decelerating trends are alleviating some of the pressure on the Federal Reserve to continue its policy of tightening.

Recent statements from various regional Federal Reserve presidents have revealed differing perspectives on the trajectory of rate hikes, with some foreseeing their conclusion while others anticipate further increases. Regardless of these viewpoints, a consensus has emerged that elevated rates will likely persist for the rest of the year.

The latest CPI report enhances the likelihood of the Federal Reserve maintaining unchanged interest rates at the upcoming September meeting. According to the CME FedWatch Tool, there is a 90.5% probability that the Federal Reserve will keep interest rates steady at its next meeting.

The progress in curbing inflation, coupled with robust economic growth and a gradually cooling labour market, represents another stride in the right direction for the central bank.

The highest interest rates in 22 years have played a pivotal role in mitigating inflation without substantially impacting economic growth. The first two quarters of 2023 witnessed GDP gains of 2% and 2.4%, respectively, and the Atlanta Federal Reserve is forecasting third-quarter growth of 4.1%.

Source: TradingView

From a technical analysis perspective despite constructive price action and supportive momentum conditions, given the stellar run from the onset of the year, price action in the near-term is likely to become choppier. Still a re-test of the previous all-time high posted in November 2022 is feasible.

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