The US CPI rose 8.5% in July from a year ago, lower than 9.1% in June

The US CPI rose 8.5% in July from a year ago, a slowing pace from the previous month due largely to a drop in gasoline prices. On a monthly basis, prices were flat as energy prices declined 4.6% and gasoline fell 7.7%. That offset a 1.1% monthly gain in food prices and a 0.5% increase in shelter costs.

Whatever the US CPI report shows the markets seem to be banking on an easing of inflationary pressure ahead as many signals seem to be suggesting that supply chain problems are easing and that firms’ price expectations are no longer increasing at the pace we saw a short time ago. But is it too early to declare victory over inflation?

It is abundantly clear that supply-chain pressures are easing. This can be seen in data such as shipping freight rates, PMI surveys, and other surveys of business price expectations. The NY Fed puts the various supply chain indicators together, and this measure has fallen by more than 50% this year, although it has to be remembered that it had risen nearly nine-fold since just before COVID-19 struck in early 2020.

We also have to bear in mind that the current reading of 1.84 is still substantially above the average reading of -0.3 that existed from the start of the survey in 1997 through to the start of 2020. But as long as this measure is moving in the right direction, along with other price influences, such as commodity prices, the market will be hopeful that, whatever US CPI shows this month, price pressure will start to ease. This seems to be a reasonable view. Even those, such as ourselves, who continue to argue that inflation pressure is greater than generally assumed, will admit that annual inflation rates will come down. The key, of course, will be the extent to which inflation falls.

As mentioned recently, the likes of the FED and ECB see inflation, close to 2% within the next 2 years, or so, and the BoE’s latest forecast shows inflation at just 0.8% at the end of its forecast period in Q3 2025. Mr. Steve Barrow, Head of Standard Bank G10 Strategy, thinks these estimates are too low.

"The concern we have is that while goods-related supply pressures may be easing, those on the labour side are not. As we know, labour markets are extraordinarily tight in most developed nations, and especially in the US, where nearly two jobs are available for every unemployed person. Existing workers who face a huge squeeze on their living standards from the surge in inflation will be tempted to bargain for much higher wages, or move jobs, because they won’t fear becoming unemployed", said Mr. Steve Barrow.

It is a perfect recipe for cost-push inflation from the labour side to complement, or even replace, the cost push pressure that’s been coming from the goods side due to supply chain pressures. And while policymakers at central banks won’t want to see labour costs accelerate rapidly, most governments are actively engaged in trying to ensure that a greater share of the value added in their economies goes to labour.

Policies such as sharp hikes in minimum wage rates and increases in corporate taxes on profits in places such as the UK and US are designed to ensure that the disproportionately large share of value added that goes to firms comes down, while that which goes to labour goes up. That, in Mr. Steve Barrow’s view, is one of the reasons why equities and corporate credit markets are weak.

The counter argument is that inflation expectations are well anchored and, hence, workers won’t push for "unreasonable" wage increases. That is true. In the US, the current 5-10 year inflation expectation among consumers is just 2.9% according to the University of Michigan consumer sentiment index, which is less than a third of the 9.1% annual CPI rate.

In the early 1980s, CPI inflation was just over 14%, while long-term inflation expectations were around 10%, according to the same survey.But while we accept that inflation expectations are lower now, so too is the unemployment rate. Back in the early 1980s, the US unemployment rate rose to over 10% and, while unemployment may rise in coming months, it seems unlikely to go much above 4% given the huge number of vacancies.

Mr. Steve Barrow remains concerned that wage pressures are – and will continue to – replace goods price pressures as the mainstay of elevated inflation and, if that’s correct it will force central banks to push rates to higher levels than the market expects and to keep them there for longer than investors anticipate.