US inflation fall paves way for interest rate cut

Inflation in the United States cooled last month, leaving the US Federal Reserve poised to cut interest rates for the first time in four years next week.
Figures from the US Bureau of Labor Statistics revealed that prices growth in the world’s largest economy had dropped to 2.5 per cent on an annual basis in August, from 2.9 per cent in the previous month, slightly below Wall Street forecasts. Inflation is now at a three-year low.
On a monthly basis, prices growth remained unchanged at 0.2 per cent. Core inflation, which is closely watched for clues on the strength of underlying price pressures, jumped to 0.3 per cent from 0.2 per cent, exceeding projections.
The latest figures are likely to foreshadow a 0.25 per cent reduction in borrowing costs next Wednesday by the Fed. Jerome Powell, its chairman, said last month that “the time has come” to loosen monetary policy.
Traders trimmed their bets on a larger cut of 0.5 per cent after the release of August’s inflation data and they now see an 85 per cent chance of a quarter-point reduction, according to CME Group’s Fed Watch tool. Cuts worth 1 per cent are priced in for the remainder of the year.
From nearly zero, the federal funds rate has reached a range of 5.25 per cent to 5.5 per cent, the highest level in 23 years. The Fed is mandated to generate maximum employment and to keep inflation at 2 per cent over the medium term.
The S&P 500, Wall Street’s benchmark share index, fell by 24.13 points, or 0.4 per cent, to 5,471.39 in early trading, while the FTSE 100 in London was broadly flat. The pound weakened against the dollar. The yield on the benchmark ten-year US government bond inched up to 3.67 per cent.
Less attention has been paid to the monthly inflation statistics in recent weeks as investors’ concerns about a recession outweigh rising prices. US labour market data last month was well below analysts’ expectations, sparking a cascade of stock-selling and amplifying calls for the Fed to cut interest rates.
“The likelihood of a 0.5-percentage-point cut from the Fed next week has taken a big knock with this [core inflation] number, but it won’t be enough to stop the Fed cutting at all,” Neil Birrell, chief investment officer at Premier Miton Investors, said. “They are still walking a tightrope between beating inflation and maintaining growth, which will mean that more moderate policy measures will prevail for now.”
James McCann, deputy chief economist at Abrdn, the fund manager, said: “There is a sense that the inflation story is starting to become yesterday’s news. The deeper concern might be that the economy is losing steam quite rapidly.”
The Fed is the last of the big central banks to have kicked off its monetary policy loosening cycle. The Bank of England cut Britain’s borrowing costs by 0.25 per cent on August 1, the first reduction since March 2020, while the European Central Bank started relaxing its policy in June.
Members of the Bank’s monetary policy committee, the nine-strong panel that sets the base level of interest in the UK, is expected to keep borrowing costs on hold at 5 per cent at its meeting next Thursday. The ECB could cut rates at its meeting this week.