Drop in US inflation boosts hopes of Federal Reserve rate cut

Inflation in the United States fell to a three-year low in July, raising expectations of an interest rate cut in the world’s largest economy next month.

Official figures showed a drop in headline annual consumer price inflation from 3 per cent to 2.9 per cent, compared with the same month last year. It was the weakest inflation reading since March 2021 and came in below analysts’ expectations of no change in July.

A key measure of monthly core inflation rose by 0.2 per cent between June and July, in line with expectations. Annual core inflation, which strips out volatile components such as energy, dipped to 3.2 per cent from 3.3 per cent, the fourth consecutive month of falls, and defying expectations of no change last month.

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The inflation figures will add to predictions of an imminent interest rate cut from the US Federal Reserve, the country’s central bank, at its next meeting on September 18.

Traders believe there is a 50 per cent chance that the Fed will make a half percentage point cut to borrowing costs next month as it battles with a slowing labour market and market jitters about a potential recession.

The Fed fund rates sits at 5.25-5.5 per cent at present, the highest since 2007. Markets are expecting two more quarter-point cuts by the end of the year, as well as the cut in September, to take borrowing costs to 4.25-4.5 per cent.

Isabel Albarran, investment officer at Close Brothers Asset Management, said that a larger rate cut next month was unlikely, adding: “Nonetheless, the labour market can cool quickly once it turns, and employment is now on the Fed’s mind as much as inflation.”

July’s inflation numbers were driven lower by broad declines in goods prices, led by second-hand cars. Housing inflation remained high, however, rising by 5 per cent compared with a year earlier.

Analysts at Pantheon Macroeconomics forecast that US headline inflation would end the year at 2.7 per cent and hit the Fed’s 2 per cent target over the course of 2025.

This week’s inflation release was being closely watched by investors after US stocks suffered their worst trading days in more than two years last week on the back of a slowdown in jobs growth in July. This raised fears of a recession. Analysts at Goldman Sachs, an investment bank, have raised their recession odds from under 20 per cent to 41 per cent, based on their financial market models.

The US dollar fell on the back of the inflation data, declining by 0.17 per cent against a basket of major currencies. On Wall Street equity markets turned positive after a mixed start with the broadly based S&P 500 closing up 20.78 points, or 0.4 per cent at 5,455.21 in New York while the Dow Jones industrial average rose 242.75 points, or 0.6 per cent, to finish on 40,008.39.

The dollar also weakened during trading after US producer price inflation rose by just 0.1 per cent between June and July, adding to evidence that broader cost pressures across the economy are slowing.

Brian Coulton, chief economist at Fitch Ratings, said that a rate cut next month was now “sealed”. He said: “That confidence had already been returning in the last couple of months and this print will reinforce it, helping to seal the deal for a September Fed rate cut.”

Scott Anderson, chief economist at BMO Capital Markets, the investment banking subsidiary of Bank of Montreal, said: “This report shows continued progress towards the Fed’s inflation goals. Nothing in it would keep the Fed from cutting in September, but market hopes for a bigger cut still seem like a long shot.”