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Economic Report: Inflation is slowing, U.S. August CPI to show, but not enough to mollify a worried Fed

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The U.S. inflation rate is on track to fall in August after slipping from a 40-year high in July, but consumer prices are still rising too rapidly to prevent another big increase in the Federal Reserve’s benchmark interest rate at its meeting later this month.

The consumer price index, the nation’s main inflation gauge, was flat in July after a steep drop in gasoline prices. Gas price fell again in August and the CPI could actually turn negative for the first time since May 2020, shortly after the start of the pandemic.

Economists polled by The Wall Street Journal predict consumer prices declined by 0.1% in August. The CPI is published on Tuesday morning.

If so, the yearly rate of inflation could slow to 7.9% from 8.5% in July and 9.1% in June. The June reading was the highest since 1981.

Falling gasoline prices could also curb inflationary pressures in September and October. Crude oil prices have declined and gasoline demand usually tapers off at the end of the U.S. summer driving season.

So the Federal Reserve should be prepared to back off on plans to sharply raise its benchmark short-term interest rate at its policy meeting in late September, right? Not so, economists say.

Fed officials believe inflation is starting to slow, but they are worried about a broadening of prices pressures to a wider range of goods and services over the last year that encompass most of the economy.

The cost of fuel, food, rent, housing, cars and trucks and many other goods and services have risen sharply — and there’s not much relief in sight.

A separate measure of consumer prices, known as the core CPI, underscores the point. The core rate, which excludes volatile food and energy prices, is likely to rise another 0.3% in August.

As a result, the yearly increase in the core inflation rate could actually move higher to 6.1% from 5.9% in July. That’s more than triple the average annual rate of inflation in the decade prior to the coronavirus pandemic.

The Fed views core inflation as a better tool to determine where inflation is headed. And right now, Fed officials see price pressures as still far too high.

The question then, is how much the Fed plans to raise its benchmark short-term rate when officials gather in Washington on Sept. 20-21 to debate their next move.

The rate helps determine the cost of borrowing for credit cards, mortgages, auto loans and business loans. Higher rates slow the economy and can even trigger recessions.

Wall Street leans toward the view that the central bank will raise the rate by another 0.75 percentage points to a range of 3% to 3.25%. Just seven months ago the rate was near zero.

But a particularly soft CPI report could sway the Fed to lift rates by just 1/2 percentage point, some economists say.

The devil is in the details. If the cost of food and rent, for example, come off a boil in August, the Fed would have more reason to go easy, they say.

Yet economists who believe a bigger rate hike is baked into the cake point to the scorching labor market as sufficient cause for the Fed to stay aggressive in its policy.

The U.S. added a robust 315,000 new jobs in August, for instance, and new unemployment filings fell in early September to a three-and-a-half month low.

The tightest labor market in decades is driving up worker wages at a 5%-plus annual pace — the fastest since the early 1980s. The Fed is worried that rapidly rising pay could add to inflation, making it harder to get prices back under control.

“The labor market is still over-heated, and core inflation is still increasing at too high a rate,” said U.S. economist Alex Pelle at Mizuho Securities.

In the short run, even falling gasoline prices might not make the Fed’s job much easier. Americans will have more money to spend on other goods and services, keeping the economy and labor market growing faster than the Fed would like.

The Fed “needs to see growth slow, not accelerate,” said chief economist Aneta Markowska of Jefferies LLC.

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