Fed seen delivering half-point rate hike in Sept as inflation eases

Slowing U.S. 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 coming weeks could still change the picture.
 

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

One Fed policymaker, while not immediately flagging a rate increase preference, still noted the good news.
 

Wednesday's report was the first "positive" reading on inflation since the Fed began raising interest rates in March, Chicago Fed President Charles Evans said at an event at Drake University in Des Moines. He added, though, that inflation is still "unacceptably" high.
 

Traders now expect increases in the Fed's policy interest rate to top out in December at 3.25%-3.5%. Equity markets took a similar cue on hopes for a less aggressive central bank, with the S&P 500 up nearly 2% in late morning trading.
 

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

The consumer price index rose 8.5% in July from a year earlier, Wednesday's report showed. While that marked a drop from June's 9.1% 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% 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 Karim Basta, chief economist with III Capital Management. Data on August consumer inflation will be released on Sept. 13, the week before the Fed meets, and given recent trends in energy and some other prices 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 consumer price index - which strips out volatile gas and food prices and is seen as a better predictor of future inflation - rose 0.3% from June and 5.9% from a year earlier.
 

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

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 prices pressures in the economy, rose 6.3% on an annual basis in July, compared to 6% in June.
 

"Overall, prices remain uncomfortably high," wrote 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 support the case for another aggressive rate hike in September."