US inflation supports September rate cut
Economic data from the US, UK, Japan, and Australia show mixed inflation and growth signals. Central banks weigh rate cuts amid cautious optimism and evolving labor market dynamics.
Weekly highlights
OK for September cut
Up two-tenths
Broad, sharp gains
Upside surprise
Weakening
Continues to slow down
Handsomely beat expectations
Finally, a cut!
In line with expectations
US: Inflation perfectly compatible with September rate cut
The inflation updates for July have been mixed but remain perfectly compatible both with a Fed rate cut in September and further additional reductions. We maintain our long-standing call for 75-bp worth of rate cuts this year.
July’s consumer price inflation was in line with expectations, with overall prices rising 0.2% m/m and core prices (excluding food and energy) rising 0.3%. The headline inflation rate was unchanged at 2.7% y/y, while the core inflation rate rose two tenths to 3.1%. While the latter was a touch higher than expected, the number rounded up to 3.1% by the smallest of margins (0.02%). Within the details, goods prices were flat and services prices increased 0.3%. Goods prices were flattered by food (0.0% m/m) and energy (-1.1% m/m); core goods prices, on the other hand, increased by 0.2% m/m, the same as in June. New car prices were flat and used car prices rose 0.5%; this was the first increase in five months and likely to be followed by another given signals from auction prices. Airfares also rebounded sharply. Most importantly, perhaps, the news on the shelter front remains supportive, with disinflation continuing. Shelter costs rose a modest 0.2% m/m for the second month in a row (though this was a high 0.2%) and shelter inflation eased another two tenths to 3.6% y/y. We are counting on a few further tenth’s reduction here before year-end to counter further increases in goods prices.
The PPI release came in hot, with the headline inflation rate accelerating nine tenths of a percentage point to 3.3%. Goods inflation accelerated two-tenths to 1.9% and services inflation surged 1.3 percentage points to a four-month high of 4.0%. This was unexpected, but we suspect it may have to do more with base effects and seasonal adjustment anomalies than a broad-based resurgence in services inflation. The reason is that last year PPI services inflation dipped a full percentage point between June and July, before increasing again thereafter. As such, it could be a timing anomaly to some extent so the 3.4% average of last two months of services PPI inflation is perhaps a better gauge of underlying trend.
After two sizable declines, inflation expectations ticked up again in the preliminary University of Michigan survey, which is likely why the sentiment measure deteriorated. Short term (1-year) expectations increased four-tenths to 4.9% and long-term (5-10 year) expectations rose five-tenths, putting them roughly back where they were in June.
The combination of the hotter-than-expected PPI data, rebound in inflation expectations, and a decent July retail sales print caused traders to trim scale back rate cut expectations, though September remains almost fully priced. We continue to believe both that 75 bp worth of cuts this year is the right policy move, and that the Fed will actually deliver them. Figure 1 above is a reminder that US inflation is about a lot more than just goods and tariffs and ongoing shelter disinflation offers a powerful tariff offset. Moreover, while jobless claims have once again flatlined, they are almost guaranteed to take another step higher in October as the federal government employees who took the deferred layoffs deal come to the end of that arrangement. It is possible that many could move straight into new employment, but that all of them, would do so seems unlikely. Jobless claims will rise as a result. With nine months having passed since the last cut, the FOMC is well positioned to resume the rate cutting cycle in September.
UK: Solid growth on surface
Despite ongoing uncertainty, Q2 GDP growth of 0.3% appears moderately positive at first glance. Stronger activity in June, along with upward revisions to April’s previously reported 0.3% decline, produced a respectable quarterly performance.
A detailed analysis, however, indicates that the underlying trends are less impressive. Most of the growth was driven by increased government consumption, which the ONS attributes primarily to a higher volume of vaccinations, an indicator that does not necessarily signal core economic strength. Moreover, results were inflated by volatile factors such as inventory changes, while key components including household consumption and business investment remained considerably weaker compared to earlier in the year.
The Bank of England (BoE) is unlikely to place significant weight on the strong Q2 results. The Bank has noted that, despite robust headline GDP numbers, real economic growth was limited in Q1. Historical trends further suggest that growth statistics are generally higher during the first half of the year before moderating thereafter, indicating potential issues with seasonal and inflationary adjustments. While Q2 GDP may embolden those arguing for caution on rate cuts, future policy decisions will primarily depend on upcoming inflation and employment indicators.
The labor market is showing signs of moderation. However, the decline in payroll employment has been relatively modest, suggesting that severe impacts following major tax increases and Living Wage adjustments have likely subsided. Meanwhile, wage growth is slowing, with regular private sector pay rising 4.8%, down from 4.9%, keeping pace with the Bank of England’s September forecast of 4.6%. This suggests that the BoE may still have scope to lower interest rates in November, although last week's hawkish policy meeting has rendered this outlook less certain.
Japan: Handsome GDP beat
The preliminary estimate of Q2 GDP growth of 0.3% q/q (1.0% annualized) came in markedly above expectations of 0.1% (0.4%). Furthermore, Q1 data was also revised up to 0.0% from a negative 0.2%.
The upside surprise in Q2 reflected broad-based strength. Private consumption rose 0.2% q/q (0.6% saar), a fifth consecutive gain. Furthermore, consumption growth averaged 0.41% q/q in the last five quarters, which is significantly faster than averages since 2000 (0.13%), 2010 (0.09%) and even 2023 (0.12%). This suggests a massive divergence between subdued consumer confidence and incoming data. The Q2 rise was underpinned by a 2.6% (10.9%) jump in spending on durable goods, which may not be sustained and is the key risk in the immediate term.
Capital expenditures (1.3% q/q) and private housing investment (0.8%) remained strong and external demand resilient in the face of frontloaded exports (2.0%) due to higher tariffs. Net exports added 0.3 pp to growth as imports grew slower.
Real employee compensation will be critical to watch going forward as it underpins the outlook for domestic consumption. It rose a solid 0.8% q/q in Q2 after a 1.5% decline in Q1. We are optimistic as minimum wages are set to rise 6.0% in October.
All these factors pave the path for the Bank of Japan’s (BoJ) next rate action; we continue to favor a move before the market pricing of under 20 bps in December at the time of writing.
Next week we expect inflation to have remained stable above 3.0% mark.
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