US inflation comes in lower than expected but Fed's tightening focus will remain

US headline consumer prices index inflation has surprised on the downside as data today showed the annual rate at 8.5% for July, compared to consensus expectations of 8.7%. The July rate is down from the 9.1% recorded in June.

On a monthly basis, which is receiving close attention from the Fed, CPI rose 0% (consensus 0.2%), compared to 1.3% in June. Lower gasoline prices were one of the main factors pulling the headline CPI print down.

The less volatile core CPI inflation measure, which excludes food and energy, rose by 5.9% from a year ago (consensus: 6.1%), matching the June print. On a monthly basis, core CPI rose 0.3% (consensus 0.5%), compared to 0.7% in June.

Rob Clarry, Investment Strategist at UK wealth manager Evelyn Partners, comments:

The key question that markets have been grappling with over the last month is whether the Fed will deviate from its current tightening plans ─ the so called ‘Fed pivot’. Falling commodity prices, deteriorating consumer confidence, and slowing growth could tempt the Fed to take its foot off the gas in upcoming meetings.

But, in our view, the main factors influencing the Fed are the labour market and inflation itself. The US labour market remains tight, which points towards continued inflationary pressures. More importantly, headline CPI remains elevated and, despite today’s fall, remains a long way from target.

Meanwhile, the Fed has reiterated that it’s committed to restoring price stability “unconditionally”. These factors point towards the Fed continuing with its plans to further increase interest rates through 2022.

While today’s downside surprise is likely to be welcomed by investors, the data does not change our view that US interest rates will continue to increase. More substantial falls in inflation and a softer labour market will probably be required before we get any signs of the Fed changing course.

With the Fed prioritising inflation over growth, we expect the US economy to continue to slow. Investors should protect their portfolios against this risk, and we like US government bonds as a way of offsetting equity risk in multi-asset portfolios.