US Inflation Hits 43-Month Low at 2.5% YoY in August: Wall Street Raises 25bps Fed Rate Cut Bets

US Inflation Eases, Supporting Rate Cut Bets

Inflation in the US cooled for the fifth consecutive month in August, boosting expectations for a 25 basis point (bps) interest rate cut by the Federal Reserve. The Consumer Price Index (CPI) rose just 2.5% year-over-year, the lowest since February 2021, down from 2.9% in July. This slowdown reinforced Wall Street's optimism about a rate cut next week.

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However, core inflation, which excludes volatile food and energy prices, rose by 0.3% from July and 3.2% year-over-year, driven by higher housing and travel costs. This unexpected uptick tempered hopes of a larger 50 bps cut, as the Fed remains cautious about persistent underlying inflation.

Core Inflation Stays Sticky, Driven by Housing Costs

Despite the headline CPI figure declining, core inflation picked up. Housing costs surged by 0.5%, led by rents and hotel accommodations. Airfare prices also rebounded, rising by 3.9% after falling in July. Economists view core CPI as a key indicator of future inflation trends, and its persistence signals that inflation pressures have not fully subsided.

Energy prices fell 0.8%, gasoline dropped 0.6%, and electricity became 0.7% cheaper, providing some relief to consumers. Food prices edged up by just 0.1%, with grocery prices remaining mostly stable.

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Fed Rate Cut Likely, but Caution Prevails

With inflation nearing the Fed's 2% target and the labor market cooling gradually, policymakers are expected to cut rates by 25 bps. The Federal Reserve has raised rates by 525 bps since 2022, but the recent moderation in inflation and wage growth gives the central bank room to pivot towards supporting the job market.

While some had anticipated a larger rate cut, the rise in core inflation dampened those expectations. The CME Group's FedWatch Tool now shows an 85% chance of a 25 bps cut, up from 71% before the CPI data release.

Outlook: Modest Rate Cut Expected

As the Fed prepares for its September 18 decision, the focus has shifted from inflation to employment. Recent improvements in supply chains, lower oil prices, and easing rent pressures suggest inflation may continue to decline. However, with core inflation still sticky, a gradual reduction in rates is more likely. A quarter-point cut would mark the start of the Fed's effort to stimulate the economy without reigniting inflation.

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