Inflation May Have Slowed in August. That May Not Be Good News.

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Inflation is expected to have slowed down in August. Don’t breathe a sigh of relief yet, experts say.

Economists are predicting the consumer price index—a key inflation metric—to have fallen by 0.05% in August, bringing annual headline inflation down to 8.1% from 8.5% the previous month, according to FactSet.

“Declining gasoline prices will deliver a flattish or negative headline inflation,” wrote Citi economist Andrew Hollenhorst.

Gasoline has been one of the main drivers propelling inflation upward this year, as energy and oil prices skyrocketed in response to the war in Ukraine. Other factors, including falling prices for used cars and a deceleration in the housing market will also help bring headline inflation down, Hollenhorst added.

On the surface, that is a good thing for markets, which have been anxiously waiting for a clearer indication that inflation is coming down from its highest point in four decades. July’s lower reading provided some hope, and even sent markets rallying in the wake of the report. A better-than-expected reading could also have a positive effects on markets.

“Although one month does not make a trend, we see the July CPI report as containing nascent evidence that the pandemic-induced shock to relative goods prices may be in the early stages of reversing,” wrote

Bank of America

economists.

But all signs point toward August’s reading being a double-edged sword.

For one, a market rally could do more harm than good, says Phillip Toews, CEO of Toews Asset Management. Toews believes that rather than seeing a constant decline in inflation over the next few months, the economy will see waves of inflation. In that case, a strong positive move in financial markets would be “the worst thing for the Fed,” he said.

“If we see some positive numbers on inflation now that sends the economy higher, we may see a negative effect on inflation later,” Toews said.

“What we need to see is, frankly, the kinds of things that cause damage to equities and financial assets in order to have success,” he added.

Another troubling sign is that while headline inflation is expected to fall, core inflation, which strips away the volatile food and energy categories, is forecast to rise. Core inflation tends to provide a more accurate reading of underlying long-term inflation trends, making it a key metric for the Federal Reserve to evaluate as it goes about setting monetary policy. Economists are predicting core CPI will tick up to an annual rate of 6.1%, up from 5.9% in July.

“The signal is that inflation is still fairly broad-based and well above the target, and so the Fed is going to have to continue with its aggressive stance,” says Megan Greene, global chief economist for the Kroll Institute.

That is not necessarily a surprise. Over the last few days, several Fed officials, including Chairman Jerome Powell, have sought to emphasize the central bank’s commitment to maintaining an aggressive stance on monetary policy until inflation is under control.

“History cautions strongly against prematurely loosening policy,” Powell said on Thursday, during a moderated discussion at the Cato Institute. “I can assure you that my colleagues and I are strongly committed to this project and we will keep at it until the job is done.”

As of Friday afternoon, investors were pricing in a 90% chance that the Fed will announce a 75 basis point hike during its meeting later this month.

Write to Sabrina Escobar at sabrina.escobar@barrons.com