FOMC Watch - Hot CPI forces Fed hike

August CPI inflation came in slightly hotter than expected. Core CPI rose by 0.29% m/m and headline CPI by 0.40% m/m. The y/y core rate fell to 2.4%, its lowest level in several years, but the three-month annualised rate, which we had previously highlighted as evidence that disinflation remained on track, increased from 1.64% to 1.97%.

The composition of inflation attracted particular attention this month. Partly because of its implications for the upcoming PCE release, but also because of the signal recently emphasised by Warsh: the share of categories experiencing outsized price increases. Gasoline prices rose by 3.9% in August and accounted for roughly one-third of the monthly increase in headline inflation. Within the core basket, prices increased for communications services, airfares, education, vehicles and lodging away from home, while medical care and motor insurance prices declined. Wireless services alone contributed around 10bp to the monthly core reading.

That concentration matters. A narrow set of categories accounted for a disproportionate share of the upside surprise, which may argue against reading the report as a broad-based reacceleration in inflation. Even so, we estimate the data are consistent with core PCE inflation of around 0.3% m/m, pushing the y/y rate up to 3.4%, excluding the methodological changes due to be introduced in the next release.

In our Global Monthly, we outlined the positions of the various voting members of the FOMC. Our view was that an inflation print broadly in line with expectations, combined with the continuing disinflation trend, would probably have been enough to keep a majority on hold. This report is unlikely to provide that reassurance. While not dramatically stronger than expected, it weakens the case for patience and could be enough to shift one or two members into the hiking camp, creating a majority in favour of tightening.

We therefore expect the Fed to raise rates by 25bp at next week's meeting. An additional hike in December also looks much more likely. We will be communicating a full forecast update early next week.