CPI could be Fed’s last gut check before interest rate decision

We get a new inflation reading Wednesday in the form of the consumer price index for August. The CPI is the last major inflation reading the Federal Reserve will get before its interest rate policymakers meet next week, when they’re expected to cut rates. It means it’s the Fed’s last gut check.

The question is, at this point, how important is any one CPI reading, especially after the worse-than-expected jobs report that was released last week?

For more than three years, the consumer price index has been a highly anticipated data point. This time around?

“I think this week’s CPI reading is important,” said Julie Smith, an economist at Lafayette College. “But really, probably in the scheme of things, not all that important.” 

Smith said an interest rate cut is probably coming regardless of what happens with the CPI. That’s because we’re far enough along in the battle with inflation where it’s not just about the headline number. For the Fed, it’s about all the little numbers.

Say food inflation is a little high and a bird flu outbreak drives up the cost of eggs. “And if they can see, well, it was factor X that caused the inflation reading to be higher, then they can sort of discount that as they move forward,” Smith said.

As they move forward, the attention is not on whether a cut is coming, but how big it will be, according to Ken Kuttner, a former staff member at the New York and Chicago Federal Reserve banks.

“Twenty-five basis points, a quarter of a percentage, is in the bag. But if we saw a good CPI number, if CPI continued to go down, then they would probably see their way clear to even maybe doing 50 basis points, half a percentage point,” Kuttner said.

The fact that we’re even talking about 25 versus 50 means there’s real concern about how well the Fed is holding up its other mandate — maximum employment — especially after last week’s slightly sour jobs report.

“We really need to do something about the labor market weakness, but we don’t have a lot of room to move because the inflation rate is still out of our comfort zone,” Kuttner said.

Kuttner said this is the turning point. Traditionally, the Fed tends to move conservatively, but it was criticized for moving too slowly when inflation started rising. It probably doesn’t want to make the same mistake again.