US inflation slows to 2.9% in July

The latest inflation numbers out of the US show that the economy is slowing as expected, locking in the chance of a quarter-point rate cut come September.

According to the report from the U.S. Bureau of Labor Statistics, the headline Consumer Price Index (CPI) number slowed to 2.9% in July, from 3% in June. That’s the lowest American inflation reading since March 2021, and marks considerable progress since the measure hit a 40-year peak of 9.1% in June 2022. 

The “Core” inflation measure – which strips out food and energy costs – rose 3.2% year over year (down from 3.3% in June), which the Bureau notes is the smallest 12-month increase for the index since April 2021. On their own, American food costs rose 2.2%, and energy increased by 1.1%, both unchanged on a monthly basis. However, the majority of the price growth was within the housing category, making up almost 90% of the increase to the all-items index. This shows fewer areas of the economy are experiencing growth.

An economic fine line

Economists and markets awaited today’s report with baited breath, as it walks a fine line between expected progress in the US inflation fight, and fears the economy is decelerating at too-fast a face. Had the CPI fallen faster than consensus, it could have reignited the recession fears that upended global markets last Monday, following a softer-than-expected labour report in which the unemployment rate rose to 4.3%.

Instead, markets have remained relatively stable following this morning’s report, as expectations firm up for a quarter-point cut from the US Federal Reserve in their September 17 - 18 announcement. It also eases speculation of a heftier 50-basis-point or “emergency” rate cut that some economists had called for during the “stock wipeout”. According to CME FedWatch, which tracks the likelihood of the timing and size of future cuts, the chance of a half-point decrease dropped to 55%, compared to 68% last week.

US Treasuries rose slightly on the news, with the 10-year inching up to 3.858% and the two-year yield increasing to 3.977%. In Canada, the five-year government bond yield (which lenders largely use as the pricing floor for their fixed mortgage rates) has stayed in the 2.9% range since last Monday, which has put downward pressure on mortgage rates. Currently, the best insured five-year fixed rate available is 4.29%, the lowest seen since May 2023. More discounts could be in store should yields trend lower upon this latest economic data.

Analysts are now largely expecting another three quarter-point cuts to come from the Fed before year-end (one each in September, November, and December), which would total a decrease of 0.75% to the Federal Funds Rate, currently in the range of 5.25 - 5.5%. The rate has hovered at this 23-year high since July 2023. Following the Fed’s rate hold in July, Chair Jerome Powell made it clear that rate cuts are “on the table” should inflation and jobs trend lower – both of which have since been confirmed by data. 

And, despite market jitters, economic easing is going according to plan, write RBC economists Nathan Janzen and Abbey Xu – but all eyes will be on the next batch of employment and CPI numbers.

“The U.S. economic backdrop isn't collapsing in a way that would force the Federal Reserve to panic. But a gradual rise in the unemployment rate is increasing the odds that wage growth and inflation will continue to drift lower, and interest rates are still at levels well above the Fed's estimate of long-run neutral,” they write in an economic note.

“The Fed will still get another jobs and inflation report ahead of the next scheduled interest rate decision in September, but we continue to look for a 25 basis point rate cut at that meeting and think risks of a larger 50 basis point reduction would be contingent on a significantly more pronounced (and unexpected) deterioration in labour market data for August.”

Clearing the path for more Bank of Canada rate cuts

Now that a steady rate cut path has been established for the US Federal Reserve, it further supports the rationale for the Bank of Canada to continue its own cutting cycle, with firm expectations of another quarter-point rate cut on September 4th. That would bring the BoC’s Overnight Lending Rate down to 4.25%, following 0.25% decreases implemented in June in July, and further push variable mortgage rates lower.

However, the chances of a Canadian rate cut were already firmly cemented, as inflation has proven easier to tame north of the border, easing to 2.7% in June.

In the BoC’s Summary of Deliberations released last week, the central bank’s council indicated there was a “clear consensus” to cut the July rate, as the bank’s preferred core measures had “eased meaningfully” since April, now falling to within the inflation-control range for several months. Canadian shelter inflation – which is a major contributor to our CPI basket – has also eased, as mortgage rates have started to decline. Overall, the BoC expects inflation to hit its 2% target some time in 2025. Consumer spending and economic growth could also be hindered as the effect of upcoming mortgage renewals combine with a slowing labour market.

This has increased the calls for more rate cuts than previously expected; a number of Canada’s big banks revised their rate direction forecasts this week; CIBC and TD now call for a total of 200 basis points (2% in cuts by the fourth quarter of 2025, up from their previously forecasted 1.75%), which would bring the Overnight Lending Rate down to 2.5%. The other banks’ forecasts for the target rate currently range between 3.25 - 3% by the end of next year.

Also read:

• Toronto home buyers start to return following July rate cut
• What the stock sell-off means for mortgage rates
• US Federal Reserve holds rate, Chair Powell confirms rate cut is “on the table”
• Canadian GDP grows 0.2% in May, BoC still on track to cut rates