U.S. consumer prices rose more than expected in July, reinforcing our view that the Fed will continue its gradual pace of interest rate hikes, at least for now.
July’s U.S. CPI (Consumer Price Index) report showed core inflation accelerated to a 2.4% annual rate, up from 2.3% in June, as businesses may have started to pass on rising costs of industrial metals and fuels. Price hikes ahead of potential tariffs could have also contributed to the rise in core CPI. However, prices of consumer services, including shelter, which tend to be more sensitive to the domestic business cycle, continued to trend sideways.
Looking ahead, the extent to which inflation from higher input costs continues to accelerate will depend in part on the price sensitivity of consumers and whether trade tensions between the U.S. and its trading partners escalate further. For now, we continue to forecast core CPI inflation will end the year at around 2.3%, but would note that the Trump administration’s trade policies present a near-term upside risk to our inflation forecast.
Overall, today’s print doesn’t change our view that domestic inflationary pressures remain manageable and one to two more interest rates hikes are likely in 2018. The Fed should be more tolerant of temporary bouts of inflation due to rising trade tensions, focusing instead on mitigating the negative effects on final domestic demand.
Car prices and appliances were driven higher – tariffs to blame?
New and used auto prices increased for the second month in a row, after deflating for the better part of last year. Automakers appear to be passing on at least some of the rising costs of steel and aluminum – input prices have increased between 10% and 20% year-over-year due to the lagged effects of the recovery in global industrial activity in 2017 and the recent moves to impose tariffs on imported steel and aluminum products. Automakers also may have begun to accelerate price hikes ahead of the possible implementation of auto and auto parts tariffs. However, the late July détente between President Trump and European Commission President Jean-Claude Juncker makes auto tariffs less likely, in our view.
Price increases in large appliances (excluding laundry equipment) were also notably firm. This may reflect the rising input costs of industrial metals, similar to the auto industry, but producers could also be accelerating price hikes ahead of implementation of U.S. tariffs on Chinese imports of appliances and related parts.
An increase in consumers’ sensitivity to higher prices of durable goods suggests that producers may not be able to pass on as much of the rising input costs as they have in the past. For example, according to the Bureau of Economic Analysis, consumer auto purchases declined in June, when prices began to rise, and early indications from WardsAuto data suggest purchases continued to decline in July. Historically, a 10% rise in steel prices has tended to coincide with a 1% rise in the price of new autos. However, that pass-through rate may be more muted if a larger drop in sales volumes ensues.
For more of PIMCO’s views on the complex drivers of inflation in the U.S. and globally, please visit our inflation page.
Tiffany Wilding is a PIMCO economist focusing on the U.S. and is a regular contributor to the PIMCO Blog.