Gasoline prices dropped in August - but inflation continues to rise

Despite a 10.6 percent drop in gasoline prices, inflation showed little signs of cooling in August, as prices rose 0.1 percent compared to July and 8.3 percent compared to August 2021. According to the Bureau of Labor Statistics, increases in prices for shelter, food and medical care offset the drop in gas prices, resulting in the higher-than-expected inflation reading. Food prices increased 0.8 percent from July and 11.4 percent from a year ago, while the subindexes for shelter and medical care services were up 0.7 and 0.8 percent from the previous month, respectively.

The less volatile core CPI-U excluding food and energy rose by 0.6 percent in August, as the exclusion of gasoline and other energy commodities negated the category’s cooling effect on inflation last month. Given that inflation didn't ease as much as expected in August, it is now considered more than likely that the Fed will issue the third consecutive 0.75 point rate hike next week, after some had hoped for a more modest hike if inflation had shown stronger signs of cooling last month. Markets reacted accordingly on Tuesday, with tech stocks particularly affected on the worst day since June 2020.

When inflation started spiking in the spring/early summer of 2021, it was largely due to the so-called base effect, reversing the pandemic’s cooling effect on consumer prices a year earlier. At the onset of the pandemic, prices had taken a dive due to a sudden drop in consumer spending and fuel demand before slowly climbing back to their pre-pandemic trajectory over the summer and fall. Due to that initial dip in consumer prices, year-over-year comparisons were always going to be exaggerated for a while, but that is no longer the case.

Back in April 2021, the Federal Open Market Committee said that it was going to aim for "inflation moderately above 2 percent for some time" before raising interest rates to achieve a long-term average of 2 percent inflation. And while it remained unclear how the committee defines “moderately above” and “for some time”, it's increasingly clear that the 2-percent goal has moved out of scope for the foreseeable future even after the Fed's most aggressive rate hikes in a long time.

To eliminate the short-term effects of the pandemic, we calculated the average annual inflation rate over a moving three-year period, yielding a curve that fluctuated around 2 percent for a long time, until it took off last summer. In August, the three-year average inflation rate stood at 4.9 percent, far beyond the 2-percent goal.