Another unsettling US inflation surprise

Sticky services inflation hits 40 year high

Core CPI inflation surprised again to the upside in September, confounding market expectations for a cooling in price growth, and offsetting the downward pressure on headline inflation coming from falling petrol prices. The core CPI rose 0.6% m/m (consensus: 0.4%; ABN: 0.5%), taking annual core inflation to 6.6% y/y (consensus/ABN: 6.5%). Worryingly, services price growth hit a new 40 year high of 0.8% m/m, driven by a pickup in shelter inflation (0.8%), but helped along by continued strength in medical services and transportation. This is around three times the monthly pace of price growth prior to the pandemic. Elevated services inflation is much more concerning to Fed officials than goods or energy inflation, given that services inflation tends to be much slower moving and more ‘sticky’. Indeed, the strength in services inflation more than offset declines in certain goods prices, such as used cars, clothing and medical goods. These categories are now seeing falling prices on the back of the cooling in durable goods demand over the past few months, while the strong dollar and the easing in supply bottlenecks is also helping.

75bp November Fed hike a done deal

The inflation surprise seals a 75bp hike taking place at the November FOMC meeting, and it raises the risk that the Fed may go even further than our current base case of the fed funds rate topping out at 4.5% in the upper bound. Much will depend on the data flow over the coming months. The building blocks certainly look to be in place now for a peak in inflation – commodity prices have topped out, house prices are correcting on the back of the surge in mortgage rates, consumption is cooling and there are early signs of the labour market turning. Provided these trends continue, inflation expectations remain well anchored, and bearing in mind the lags with which monetary policy works – we think the Fed will be confident it has done enough to tighten monetary policy by the end of the year. But it will very much depend on the data.