Inflation eases to a two-year low, but will it keep the Federal Reserve from raising interest rates?

Despite inflation drop, Social Security COLA estimate revised to the upside

Another positive inflation report may be a good sign that the Federal Reserve's policy is working, but it may not be enough to stop the central bank from raising rates again this year, according to one economist. (iStock)

Inflation lowered for the 12th month running, easing to 3% in June – its lowest level in more than two years, according to the Consumer Price Index (CPI) released by the Bureau of Labor Statistics (BLS).

In June, inflation was down from the annual inflation rate of 4% in May, but it increased 0.2% on a monthly basis, according to BLS. 

The cost of housing was the largest contributor to the monthly increase in June, accounting for over 70% of the rise. Car insurance rose by 1.7% in June and was also a major contributor to growing prices. 

Whether the slowing pace of inflation will be enough to curb further Federal Reserve interest rate increases this year remains a matter of debate. The central bank has already raised rates 10 times in 2022 and 2023 in a bid to bring inflation down to a 2% target. 

In June, the Fed announced a much-anticipated pause on interest rate increases following continued moderation in inflation, acknowledging the lag time it took for its monetary action to work. 

However, Federal Reserve Chair Jerome Powell said in a recent statement that inflation remains high and has hinted that the central bank will resort to another two rate hikes this year in order to get closer to a 2% target rate.

Moody's Analytics Chief Economist Mark Zandi tweeted that June's inflation report proves the central bank's policy is working. 

"One couldn't ask for a better report on consumer price inflation," Zandi said. "Inflation is definitively throttling back, and while today's report overstates the case, there is a strong case that inflation is headed in the right direction. The Fed should rethink the need for more rate hikes."

Morning Consult Chief Economist John Leer was less optimistic that the report would be enough to dissuade the Fed from moving forward with additional rate increases.

"CPI inflation slowed to 3% in June, but don't expect the Fed to stop raising rates," Leer said in a statement. "The Fed cares primarily about the trend in core PCE inflation, which has been persistently elevated for the past six months. One month of encouraging CPI data isn't enough for the Fed to make a dovish pivot, particularly as it seeks to maintain credibility with financial markets."

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Social Security cost of living adjustments higher than anticipated

The continued drop in the average monthly inflation rate over the past 12 months was expected to negatively impact the annual cost of living adjustment (COLA) to Social Security benefits, according to a report by The Senior Citizens League (TSCL). 

However, Social Security beneficiaries could see a 3% increase in their monthly checks next year, slightly higher than the 2.7% bump estimated one month ago. A COLA of 3% would raise an average monthly benefit of $1,787.00 by roughly $53.60.

The better-than-expected COLA however may be outweighed by more expensive insurance costs, TSCL said. Americans are facing an increase in premiums for Medicare Part B, which covers doctor visits, diagnostic tests, and other outpatient services. The Medicare Trustees forecast monthly Part B premiums to increase from $164.90 in 2023 to $174.80 in 2024. $164.90 in 2023 to $174.80 in 2024

"If inflation continues to slow and the COLA for 2024 is lower, the risk that the Part B premium increase may exceed the amount of the COLA increases, especially for those with the lowest Social Security benefits," TSCL said.

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Falling car prices could leave drivers stranded

Used car prices dropped 5.2% over the last twelve months, which could put some borrowers that financed their vehicle purchase at high interest rates in a delicate position, according to Edmunds. 

Drivers have faced the double challenge of rising vehicle prices and more expensive loan terms, and a growing number are paying $1000 or more a month in financing expenses, Edmunds said in a recent report. The price drop could mean some borrowers owe more than the car is worth. 

Negative equity or being underwater on a car loan means that what a borrower owes on financing exceeds the vehicle's value. The risk for consumers is that when they want to trade in their car, they will need to cover the negative equity with their new loan, or they will have to stay in their current vehicle longer, according to Patrick Rosenberg, the director of auto finance at J.D. Power.

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