Week’s two key inflation reports to help decide size of Fed’s rate cut

The Federal Reserve gets its last look this week at inflation readings before it will determine the size of a widely expected interest rate cut soon.

On Wednesday, the Labor Department’s Bureau of Labor Statistics will release its consumer price index report for August. A day later, the BLS issues its producer price index report, also for August, a measure used as a proxy for costs at the wholesale level.

With the issue virtually settled over whether the Fed is going to cut rates when it wraps up the next policy meeting Sept. 18, the only question is by how much. Friday’s jobs report provided little clarity on the issue, so it will be left to the CPI and PPI readings hopefully to clear things up.

“Inflation data has taken a backseat to labor market data in terms of influence on Fed policy,” Citigroup economist Veronica Clark said in a note. “But with markets — and likely Fed officials themselves – split on the appropriate size of the first rate cut on September 18, August CPI data could remain an important factor in the upcoming decision.”

The Dow Jones consensus forecast is for a 0.2% increase in the CPI, both for the all-items measure and the core that excludes volatile food and energy items. On an annual basis, that is expected to translate into respective inflation rates of 2.6% and 3.2%. PPI also is projected to increase 0.2% on both headline and core. Fed officials generally put more emphasis on core as a better indicator of longer-run trends.

At least for CPI, the readings are not particularly close to the Fed 2% long-run target. But there are a few important caveats to remember.

First, while the Fed pays attention to the CPI, it is not its principal yardstick for inflation. That would be the Commerce Department’s personal consumption expenditures price index, which most recently pegged headline inflation at 2.5% in July.

Second, policymakers are as concerned about the direction of movement almost as much as the absolute value, and the trend for the past several months has been a decided moderation in inflation. On headline prices in particular, the August 12-month CPI forecast would represent a 0.3 percentage point decline from July.

Finally, the focus for Fed officials has shifted, from a laser view on taming inflation to mushrooming fears over the state of the labor market. Hiring has slowed considerably since April, with the average monthly gain in nonfarm payrolls down to 135,000 from 255,000 in the prior five months, and job openings have declined.