More good news for the Fed? 'Wholesale inflation' rose less than expected in July

A key measure of "wholesale inflation" rose less than expected in July, signaling that Americans will continue to see smaller price increases in the second half of the year.

According to the Department of Labor, the Producer Price Index (PPI) increased by just 0.1% in July and 2.2% annually. Both figures are below expectations, and the annual figure is a major drop from June’s 2.7% increase.

Meanwhile, the core PPI—which strips volatile food and energy prices—increased by 2.4% from a year ago, the smallest increase in four months.

Perhaps the most significant development was that sticky service inflation recorded its first decline this year. Service costs fell by 0.2% in July to lower prices at machinery and vehicle wholesalers.

Although Americans aren’t as familiar with the PPI as they are with the Consumer Price Index, the indicator suggests that wholesale inflation is beginning to moderate.

This is good news for all Americans because producer prices are often passed on to final product prices. Lower PPI numbers should also reflect on the Fed's favorite inflation yardstick—the Personal Consumption Expenditures Index (PCE).

Good news for the Fed

The Fed has been under enormous pressure to lower interest rates since the dismal July jobs report. Economists criticized the central bank's narrow focus on inflation.

Now that inflation is heading in the right direction, the central bank should have enough breathing room to shift its focus to the labor market.

“Producer price increases cooled this month, which is good news for the Fed’s inflation fight,” Christopher Rupkey, chief economist at FWDBONDS, told Reuters.

“Although the pass-through from producer into consumer prices is incomplete and of variable length, [the PPI] report is well within the range that allows the Fed to continue to place its primary focus on the labor market at upcoming policy decisions,” said JPMorgan economist Michael Hanson.

JPMorgan believes that current interest rates are about 1% higher than they should be.

Banks like JPMorgan and Goldman Sachs are forecasting three consecutive rate cuts beginning in September. Citigroup expects the cuts to continue well into next year.

Although markets are certain that the Fed will cut rates next month, a growing number of economists believe that the central bank waited too long to begin the easing process.

As Creditnews reported, Wharton School professor Jeremy Siegel said the Fed’s delay makes “absolutely no sense” given the progress made on inflation.

Like JPMorgan, Siegel thinks the target for the Fed Funds rate is too high. In his view, it should be closer to 2.8% rather than the current 5.5%.