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July data reveals 'significant cooling in transitory inflation'

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This article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Thursday, August 12, 2021

But other signs emerge of inflation sticking around

In a July press conference, Federal Reserve Chair Jerome Powell was asked to define this summer's biggest buzzword in markets: transitory. 

"The concept of transitory is really this: It is that the increases will happen," Powell said. "We're not saying they will reverse. That's not what transitory means [...] what I mean by transitory is just something that doesn't leave a permanent mark on the inflation process. Again, we don't mean...producers are going to take those price increases back. That's not the idea. It's just that they won't go on indefinitely." (Emphasis added.)

And the July inflation report gave us some clean examples of what the Fed chair is talking about.

On Wednesday morning, the Bureau of Labor Statistics released the Consumer Price Index for July, which showed prices rose 0.5% over the prior month, and 5.4% over last year on a headline basis. On a "core" reading — which strips out food and energy — prices were up 0.4% over the prior month, and 4.3% over last year. 

But as we discussed last month following the release of the June data, the inflation conversation right now is about two different dynamics: Price increases that might prove to be transitory, and those that could be more durable. 

And on the first point, July offered some clarity. 

"This month revealed significant cooling in transitory inflation," said economists at Bank of America Global Research. The firm cited both used car prices, which rose just 0.2% month-on-month, and airline fares, which fell 0.1% from last month, of examples of categories impacted by re-opening factors that cooled off notably in July. 

In other words, price increases in these categories recorded in prior months are proving to be temporary.

"The softer rise in core prices mainly reflected much smaller price increases in most of the pandemic-affected sectors that had driven stronger gains in previous months," said Andrew Hunter, senior U.S. economist at Capital Economics. 

"The latest data on wholesale auction prices suggest that used vehicle prices will decline outright in August which, if sustained, could become a more significant drag on core inflation over the coming months," he added.

And as we see on the following chart, both categories saw a surge in prices as demand for vehicles and demand for air travel spiked into the summer. But with high prices tapping some buyers out of the used car market — and the spread of the Delta variant impacting some travel behaviors — these pressures have waned. 

The price of airline tickets and used cars spiked in the late spring and early summer. Prices for both, however, went nowhere in July. (Source: FRED)
The price of airline tickets and used cars spiked in the late spring and early summer. Prices for both, however, went nowhere in July. (Source: FRED)

But both Hunter and the team at Bank of America noted that more persistent sources of inflation remained firm in July, potentially making life challenging for the Federal Reserve in the months ahead. 

Owners' equivalent rent — which accounts for just over one-fifth of overall consumer prices — rose 0.3% month-on-month and 2.4% over last year. The overall cost of shelter, which includes owners' equivalent rent, accounts for about one-third of inflation and rose 2.8% in July compared to last year. 

Hunter also flagged that prices at restaurants and bars were up 0.8% month-on-month in July, after a 0.7% and 0.6% gain in the prior two months, respectively. 

"Fed officials will no doubt see these figures as validating their claims that most of the previous surge in core inflation would prove transitory," Hunter writes, "but there were also signs in July’s report that more lasting price pressures are continuing to build."

"Overall, the July data suggest that the initial burst of stronger inflation is now fading, but it is still much too soon to dismiss the risks of a more prolonged period of higher inflation over the coming years," the economist added.

By Myles Udland, reporter and anchor for Yahoo Finance Live. Follow him at @MylesUdland

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