Traders bet Fed will slow rate hikes after US inflation eases, but officials say too early to declare victory

The consumer price index rose 8.5 per cent in July from a year earlier. PHOTO: REUTERS

WASHINGTON (REUTERS) - Slowing US inflation may allow Federal Reserve policymakers to downshift their most aggressive round of monetary policy tightening in decades when they meet next month, though data on tap in the coming weeks could still change the picture.

After a US Labour Department report on Wednesday (Aug 10) showed that consumer prices did not rise at all in July compared with June, traders of futures tied to the Fed's benchmark interest rate slashed bets that the central bank would enact a third straight 75-basis point hike at its Sept 20 to 21 policy meeting, and instead would opt for a half-point increase.

But Fed policymakers left no doubt that they will continue to tighten monetary policy until price pressures are fully broken.

The Fed is "far, far away from declaring victory" on inflation, Minneapolis Federal Reserve Bank president Neel Kashkari said at the Aspen Ideas Conference, despite the "welcome" news in the consumer price index (CPI) report.

Mr Kashkari said he has not "seen anything that changes" the need to raise the Fed's policy rate to 3.9 per cent by year end and to 4.4 per cent by the end of 2023.

The rate is currently in the 2.25 per cent to 2.5 per cent range.

Mr Kashkari is, to be sure, the Fed's most hawkish member; most of his 18 colleagues believe a little less policy tightening may be enough to do the trick to bring prices under better control.

Calling inflation "unacceptably" high, Chicago Fed president Charles Evans said he believes the Fed will likely need to lift its policy rate to 3.25 per cent to 3.5 per cent this year and to 3.75 per cent to 4 per cent by the end of next year, in line with what Fed chair Jerome Powell signalled after the Fed's latest meeting in July.

Still, he said, the CPI report marks the first "positive" reading on inflation since the Fed began raising interest rates in March in increasing increments - a quarter of a percentage point to start, then half a point, and then three-quarters of a percentage point in both June and July.

Traders now expect increases in the Fed's policy interest rate to top out in December at 3.25 per cent to 3.5 per cent. United States stock markets took a similar cue on the hope for a less aggressive central bank, with the S&P 500 rallying 2.1 per cent on Wednesday.

Whether those hopes are warranted will be clearer in the coming weeks. For the Fed to scale back, subsequent inflation data will need to confirm the idea that price increases are slowing.

The CPI rose 8.5 per cent in July from a year earlier, Wednesday's report showed. While that marked a drop from June's 9.1 per cent rate, prices are still rising at levels not seen since the high inflation era of the 1970s and early 1980s. Food prices in July were up 11 per cent from the year before, devastating for lower-income families in particular.

For the moment, however, analysts focused on the fact that after months in which accelerating price pressures pushed Fed policymakers to tighten credit conditions faster than at any time since the 1980s, inflation data finally surprised in the other direction.

"The Fed needs a lot more evidence (of slowing inflation)... but this is a good start," said Mr Karim Basta, chief economist at III Capital Management.

Data on August consumer inflation will be released on Sept 13, the week before the Fed meets. Given the recent trends in energy and some other prices, he said the report "should also be friendly to the disinflation path and should make a 50-basis point hike the preferred option".

Still, the Fed's battle with high inflation is far from over.

The core CPI - which strips out volatile gas and food prices and is seen as a better predictor of future inflation - rose 0.3 per cent from June and 5.9 per cent from a year earlier.

The Fed targets 2 per cent inflation based on a different index that is rising at a lower, but still high, rate of more than 6 per cent.

An alternative measure of consumer prices compiled by the Cleveland Fed, known as the Median Consumer Price Index and considered a good view of the breadth of price pressures in the economy, rose 6.3 per cent on an annual basis in July compared with  6 per cent in June.

Overall, "prices remain uncomfortably high", said chief US economist at High Frequency Economics Rubeela Farooqi, who stuck with her call for a 75-basis point rate hike next month. "Coupled with strength in job growth and wages, the data supports the case for another aggressive rate hike in September."

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