July CPI: Inflation Story Changed But Not Over — Services Inflation Now More Problematic

TradingKey - While Trump administration officials have offered an optimistic interpretation of the relatively mild July CPI report, and capital markets have responded with record gains in risk assets, economists warn that the Federal Reserve’s battle against goods inflation is not fully over, and the resurgence of services inflation will be more challenging.

According to data released by the U.S. Bureau of Labor Statistics on August 12, overall U.S. July Consumer Price Index (CPI) was moderate:

• Year-over-year CPI held steady at 2.7%, slightly below the expected 2.8%
• Month-over-month CPI rose 0.2%, in line with expectations

U.S. President Donald Trump and Treasury Secretary Scott Bessent both stated that tariffs have so far not triggered the sharp inflation rebound that economists predicted months ago, and that the current inflation picture supports the Fed cutting rates soon.

Despite the moderation in headline CPI, underlying details are concerning. On one hand, goods inflation pressures have indeed eased, but prices of goods heavily affected by tariffs — such as toys, sports equipment, and furniture — continue to rise, consistent with the tariff-driven inflation signals seen in June’s CPI.

Morgan Stanley strategist said inflation is rising — just not as much as some feared. Markets may accept these numbers in the short term, as they allow the Fed to focus on labor market weakness and make a September rate cut possible. But in the longer term, as tariffs continue to work through the economy, the current figures may not mark the end of price increases.

Samuel Tombs, economist at Pantheon Macroeconomics, said the inflation story is not over. Fluctuations in price readings are normal, but since January, price increases for key imported goods have been the largest.

On the other hand, multiple service prices showed notable increases, while the previous weakness in service prices had been a key factor keeping overall CPI from rising sharply.

Last month, the shelter index rose 0.2% month-over-month, the medical care index accelerated from 0.5% in June to 0.7%, the airline fare index jumped from -0.1% to 4.0%, the recreation index rose 0.4%, and the used cars and trucks index increased 0.5%.

BNP Paribas noted, “The surprise here was compositional, in that we saw a bit more heat in services and a bit less heat in goods. Which one of these is good news for the Fed is not clear. The Fed may in fact be more troubled by the fact that services inflation, which is more persistent, is running a little hotter.”

Capital Economics economist said the report marks a “narrative shift” — the impact of tariffs again appears negligible, but the strong rise in service prices may signal that July’s PCE inflation will once again exceed the target.

There remains significant disagreement within the Fed on the inflationary impact of tariffs. 

Although a September rate cut appears “locked in,” Kansas City Fed President Jeff Schmid said that while higher tariffs seem to have limited effects on inflation, this should be a reason to pause policy, not an opportunity to ease the policy stance.