US Daily Economic Update

Monthly Pace of Increase in US Core Inflation Slows Down

The seasonally adjusted all-items CPI rose 0.4% in July, but the less volatile and more closely watched core CPI rose only 0.2%, below the market forecast for a 0.3% increase. Tuesday’s rally in US Treasuries on the back of a round of weak data will likely continue as the monthly increase in the core inflation rate was lower than market forecasts. The report should be negative for the US dollar.

The not seasonally adjusted core CPI rose 2.7% on a year-over-year basis, the fastest pace of increase since December 2001, and above the Fed’s comfort level given its most recent central tendency forecast for an increase in the core rate of inflation of2.25% to 2.5% over the four quarters of 2006.

However, the monthly pace of increase in July was slower than in the previous four months when prices increased at a 0.3% pace and, as such, is feeding market sentiment that price pressures are abating.

The core rate increased on a year-over-year basis for the fourth consecutive month and our proprietary model tracking core inflation, which is based on the lagged impact of changes in unit labour costs and core producer prices, points to a continued climb in the core inflation rate in the months ahead.

While recent data have increased sentiment that the next move by the Federal Reserve could be an easing in interest rates, we continue to be cautious about this view and expect that, if our forecast for the core inflation rate to continue to trend higher in the months ahead proves to be correct, another 25 basis-point rate increase is more likely than an easing move.

Deceleration in US Housing Market Activity Continues

July housing starts fel l2.5% to an annualized rate of 1.795 million units from a downwardly revised 1.841 million pace in June.  The July reading was weaker than expected with the market consensus calling for a decrease to a pace of 1.810 million units. The weaker-than-expected data will be negative for the currency, positive for bonds.

Both single and multiple unit starts registered decreases, with starts of singles falling to1.452 million units from 1.486 million units and multiples starts falling to 343,000 from June’s reading of 355,000. Building permits, a precursor to future housing market activity, fell by 6.5% inJuly. The National Association of Homebuilders Housing Market Index, a gauge of homebuilders’ optimism, fell to 32 in August after falling to 39 in July.  Both of these reads are very low. 

These factors suggest that there may be continued deceleration in housing market activity. This report gives support to the view that, for the near-term, the Fed will remain on hold, but the rise in the year-over-year rate in core CPI suggests that inflationary risks remain.

US Industrial Production Slackens

In July, industrial production rose by a smaller-than-expected 0.4%, below forecasts for a 0.6% increase. The capacity utilization rate increased to 82.4% from June’s 82.3% read. The weaker-than-expected data will be positive for US Treasuries and negative for the US dollar. 

Manufacturing output rose by a modest 0.1%. The output of non-durable manufacturers was up 0.3%, while the production of durable manufacturers was unchanged. Mining output rose by 0.8%. Utilities production rose by a robust 2%, no doubt helped by the unusually warm weather in July.

The capacity utilization rate rose to 82.4%, its highest reading since the 82.5% registered in June 2000. This portion of the report supports concerns about how much slack there is in the economy.