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U.S. underlying inflation stirring; labor market tightening

WASHINGTON (Reuters) - U.S. underlying consumer prices increased by the most in nearly 1-1/2 years in June amid solid gains in a range of goods and services, but that did not change expectations the Federal Reserve would cut interest rates this month.

FILE PHOTO: People shop at an H&M store during the grand opening of the The Hudson Yards development, a residential, commercial, and retail space on Manhattan's West side in New York City, New York, U.S., March 15, 2019. REUTERS/Brendan McDermid/File Photo

Signs of a pick-up in underlying inflation and a strong labor market reported by the Labor Department on Thursday, however, further tempered financial market expectations of a 50 basis point cut at the end of the month and views that the Fed would lower borrowing costs at least twice this year.

A rate cut at the July 30-31 policy meeting, the first in a decade, is almost certain after Fed Chairman Jerome Powell on Wednesday told lawmakers the U.S. central bank would “act as appropriate” to protect the economy from rising risks such as trade tensions and slowing global growth.

“This argues against aggressive monetary stimulus from the central bank,” said Chris Rupkey, chief economist at MUFG in New York. “Fed officials are unlikely to cut interest rates more than one or two times this year no matter how badly the Trump economics team wants even more stimulus to stoke the economy’s engines of growth going into next year’s presidential election.”

President Donald Trump has repeatedly urged the Fed to cut rates because of low inflation and last week said the economy “would be like a rocket ship,” with easier monetary policy.

The consumer price index excluding the volatile food and energy components rose 0.3% last month, the largest increase since January 2018, after four straight monthly gains of 0.1%.

The so-called core CPI was boosted by strong gains in prices for apparel, used cars and trucks, as well as household furnishings. There were also increases in the cost of healthcare and rents. In the 12 months through June, the core CPI climbed 2.1% after advancing 2.0% in May.

But the overall CPI edged up 0.1% last month, held back by cheaper gasoline and food, matching May’s rise. It increased 1.6% year-on-year in June, slowing from May’s 1.8% rise.

Economists polled by Reuters had forecast the CPI unchanged in June and the core CPI gaining 0.2%.

The Fed, which has a 2% inflation target, tracks the core personal consumption expenditures (PCE) price index for monetary policy. The core PCE price index increased 1.6% year-on-year in May and has undershot its target this year.

The central bank last month downgraded its inflation projection for 2019 to 1.5% from the 1.8% projected in March. Powell on Wednesday said “there is a risk that weak inflation will be even more persistent than we currently anticipate.”

Following June’s solid increase in the core CPI, Fed officials will be watching to see if that translates into a rebound in both consumers’ and market-based inflation expectations, which have dropped over the past year.

“One of the primary reasons the Fed is going to cut rates is that inflation expectations have fallen, so if expectations bounce back it may limit the scope of the impending easing cycle,” said Eric Winograd, senior economist at AllianceBernstein in New York. “I think it will take a few months of data for that to happen.”

The dollar was little changed against a basket of currencies after the data, while U.S. Treasury prices fell. Stocks on Wall Street were mixed.

HEALTHY LABOR MARKET

In another report on Thursday, the Labor Department said initial claims for state unemployment benefits dropped 13,000 to a seasonally adjusted 209,000 for the week ended July 6, the lowest level since April. Economists polled by Reuters had forecast claims rising to 223,000 last week.

The labor market remains healthy despite the rising risks to the 10-year old economic expansion, the longest in history.

“The labor market has not weakened in a meaningful way since the escalations in trade policy a few months ago,” said Daniel Silver, an economist at JPMorgan in New York.

Economic growth is also slowing as last year’s massive stimulus from tax cuts and more government spending fades. Manufacturing is struggling, the trade deficit is widening again, consumer spending is rising moderately and the housing sector remains mired in a soft patch.

Economists expect the tightening labor market, which is lifting wages, and the imposition in May of more tariffs on Chinese goods to gradually push inflation towards its 2% target.

In June, owners’ equivalent rent of primary residence, which is what a homeowner would pay to rent or receive from renting a home, rose 0.3%, matching May’s gain. The rent index shot up 0.4%. Healthcare costs increased 0.3%, after a similar advance in May. There was a 1.1% surge in the cost of dental services, but prescription drug prices fell 0.6%.

Apparel prices jumped 1.1% after being unchanged in May. Prices for apparel tumbled in March and April after the government introduced a new method and data to calculate their cost. Used motor vehicles and trucks prices accelerated 1.6% in June after declining for four straight months.

The price of household furnishings and operations rose 0.8%, the biggest gain since 1991, driven by rising costs for gardening and lawn care services. There were also increases in the costs of motor vehicle insurance, education, new vehicles and communication.

But consumers paid less for gasoline last month, with prices dropping 3.6% after falling 0.5% in May. Food prices were unchanged last month after rebounding 0.3% in May. Food consumed at home fell 0.2% amid declines in the prices for beef, fish, eggs, cereals and fruit and vegetables.

Reporting by Lucia Mutikani; Editing by Andrea Ricci

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