Topline year-over-year inflation held steady in September at 3.7%, with month-over-month inflation slowing to 0.4% from 0.6% in August, despite the recent surge in gas prices. Core inflation (which excludes energy and food) fell to 4.1% from 4.3% over the year, holding steady at 0.3% over the month.
Over the month, the biggest driver of inflation was the 2.1% increase in gasoline prices and 2.3% increase in energy commodities prices. Both increases have since reversed, according to real-time private-sector data. Over the year, headline inflation has been largely driven by core services (including housing) and, to a lesser extent, food.
The report isn’t great news, but it isn’t bad news either. It likely won’t tilt the Fed’s November policy decision in either direction. Markets expect the Fed to hold rates steady in November, believing that the recent spike in bond yields has effectively substituted for a rate hike and tightened financial conditions enough to continue cooling inflation.
Inflation is still too high from the Fed’s vantage point, but inflationary pressures continue to ease ever so gradually. The Fed will want to see at least six months of lower inflation before declaring victory. In the meantime, higher borrowing costs are weighing on households, particularly those with credit card debt or subprime car loans, and on businesses, especially those with high levels of debt in variable-rate bonds. If rates stay higher for longer, as the Fed has signaled, that will likely drag down consumer spending and business spending—including on hiring—in the coming months.
Inflation is also still too high from the vantage point of U.S. households. While inflation is gradually cooling, U.S. consumers might not notice that because what is most salient about inflation is cumulative inflation over a longer period, not month-to-month changes. Energy prices have risen 37% and food costs 24% since the start of the pandemic. Each time Americans go grocery shopping or fill up a tank of gas, they’re reminded of the jump in prices. Even if inflation cools further, few categories will see outright price declines. So consumer sentiment may remain depressed even after the Fed declares victory and interest rates start falling.
