Inflation surged 8.5% in July, hovering at a four-decade high despite a drop in gasoline prices and adding pressure on the Federal Reserve to bring down the price of necessities.

The July reading of the Labor Department’s Consumer Price Index, a closely watched measure of the costs of goods and services, marked a slight decrease from the previous month, when inflation hit a fresh peak of 9.1%.

In a sign that broad price pressures continue to hammer the US economy, core inflation, which excludes volatile food and gas prices, increased by 5.9% annually and by 0.3% compared to June.

The latest CPI number eased as the gasoline index fell by 7.7% in July, while the overall energy index fell 4.6%. Nevertheless, food prices continued to rise, jumping 10.9% compared to the same month last year and 1.1% compared to June.

Food costs posted their highest 12-month increase since 1979. Shelter costs also rose by 0.5% month-over-month and 5.7% year-over-year. Overall, prices were flat compared to June.

Grocery shopper
Food, gas and housing are the key drivers of inflation.
AFP via Getty Images
The Labor Department’s Consumer Price Index was up 8.5% in July, off a peak of 9.1% a month earlier but still near 40-year highs.
US Department of Labor

Nevertheless, July’s CPI number was slightly lower than the 8.7% increase economists had expected, according to Dow Jones data. Likewise, economists had expected core inflation to hit 6.1% for the month. The Fed’s target for inflation is 2%.

In response, traders to shift their bets in favor of a half-point rate increase at the Fed’s next meeting on Sept. 21. Previously, the market was pricing in a 67.5% probability for a three-quarter percentage point hike, according to CME Group data.

The Dow Jones Industrial Average jumped 535.10 points, or 1.6%, to 33,309.51.

“The market is now pricing in a 50 basis point move at the September meeting and equities are responding in kind,” Neil Dutta, head of economics at Renaissance Macro Research, said in a note to clients. “This data point will fuel talk of a policy pivot. But, for me, the issue really does boil down to the labor market. Wage growth is running red hot and absent a turn around in productivity, this will ultimately fuel higher prices.”

Gas prices
Gas prices have fallen since hitting record highs in June.
AFP via Getty Images

The latest CPI data emerged just days after a July jobs report that blew away economists’ expectations.  US employers added 528,000 jobs in July – more than twice what economists expected – while wages jumped 5.2% year-over-year.

The red-hot jobs market raised concerns among investors that the Fed would implement more sharp interest rate hikes to ensure the economy is sufficiently cooled to bring down prices.

The rate-setting Federal Open Market Committee has hiked its benchmark rate by three-quarters of a percentage point, its sharpest clip since 1994, at each of its last two meetings.

Even with the decline in headline inflation, American households likely experienced little relief in July, according to Greg McBride, chief financial analyst at Bankrate. While gas prices are on the decline, the costs of other key inflation drivers such as rent and services remain historically steep.

“To relieve the pressure on household budgets and boost the otherwise sour mood of consumers, we need to see a broad-based, significant, and sustained easing of pricing pressures for the remainder of 2022 and well into 2023,” McBride said.

Two top Fed officials – San Francisco Fed President Mary Daly and Federal Reserve Governor Michelle Bowman – said this week to expect more larger-than-normal rate hikes until inflation shows signs of steady decline.

“My view is that similarly sized increases should be on the table until we see inflation declining in a consistent, meaningful, and lasting way,” Bowman said in prepared remarks for the Kansas Bankers Association, according to CNBC.

Fed Chair Jerome Powell
Fed Chair Jerome Powell is under pressure to bring down prices.

Fed Chair Jerome Powell has indicated the central bank will closely track data indicators between its July and September meetings before making any decision.

“We anticipate that ongoing increases in the target range for the federal fund rates will be appropriate,” Powell said after the most recent hike in July. “The pace of those increases will continue to depend on the incoming data and evolving outlook for the economy.”

President Biden
President Biden and his team have touted the recent decline in gas prices.

“While another unusually large increase could be appropriate at our next meeting, that is a decision that will depend on the data that we get between now and then,” he added.

Meanwhile, President Biden and his team took a victory lab ahead of the data, pointing to falling gas prices as a sign that the administration’s policies were having an effect.

Critics have alleged that Biden’s hardline stance toward domestic energy producers has exacerbated the problem.

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