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Expect inflation to end the year at 3.6%, up a bit from the current 3.4% rate, if gasoline prices stay above $4 a gallon. If a cease-fire with Iran can hold, then inflation at the end of 2026 will ease to around 3.0%.
Consumer prices rose a modest 0.1% in July from June, and the 12-month inflation rate dipped slightly to 3.4%, as gasoline prices fell 2.9%. A beneficial 0.8% decline in drug costs and only a modest rise in the cost of groceries also contributed to the low July number.
But a number of problem areas have already developed: Gasoline prices rose again soon after the July survey, which will boost August inflation. Housing costs picked up to their normal 0.3% monthly gain. Computer prices in general rose 3.5% after Apple’s price increases because the cost of semiconductors is surging amid heavy spending on artificial intelligence. Smartphone prices rose 1.1% for the same reason. Medical care, airfares, used vehicles and recreation goods also saw above-normal price increases. As a result, the “core” inflation rate, which excludes volatile food and energy, will likely end the year at 2.7%, above its current 2.5% pace. Services prices excluding energy appear to be reasserting themselves as inflation drivers. Businesses in general may raise prices just to cover their rising costs, creating another upward push to core prices. Food prices may come under new pressure by the end of the year, as one-third of the world’s fertilizer is produced in the Persian Gulf region.
The modest inflation report in July will turn all eyes to the August report, due on September 11, a few days before the Federal Reserve’s policymaking meeting on the 16th. If the August report is not terrible, then the Fed will probably leave interest rates unchanged. However, if the August report looks worse, as we expect it will, then the pressure will build on the committee to start raising short-term rates by a quarter of a percentage point at that meeting and the two following meetings in October and December. The possibility of a poor August inflation report will keep bond yields from declining much.
Another piece of important information for the financial markets will be Fed Chairman Kevin Warsh’s speech at the Fed’s annual Jackson Hole, Wyoming, conference on August 27-29. The annual speeches by Fed chairmen at this conference have often been pivotal, laying out their broad principles and views on monetary policy. Given Warsh’s reticence so far to share his plan of attack on inflation, his words in this speech will receive extra attention. The measure of inflation that the Fed watches more than the Consumer Price Index is the Personal Consumer Expenditures (PCE)index excluding food and energy, which came in at 3.3% for June (July data will be released on Aug. 26, and should be similar to June’s number). The Fed wants core PCE inflation at 2%. It was already well above its benchmark before the Iran war caused energy prices to spike.
