Fed chair Jerome Powell has pinpointed this summer as the time when the US central bank will likely learn if inflation is responding to the tariffs applied by the Trump administration on trading partners and various industrial sectors.
So far, the levies have had only a limited impact on inflation, a fact that President Donald Trump has used to excoriate Powell and demand that the Fed lower interest rates.
However, that doesn’t mean higher inflation isn’t on the way as businesses run down inventory bought before the tariffs took effect or use up other tools at hand to avoid raising prices for their customers.
“We know there is a lag between implementation and the inflationary effect,” said Gregory Daco, chief economist at EY-Parthenon.
“Businesses manage imports using different processes … We have not seen the full-blown effects of tariffs on CPI data … I would expect to start to see more,” Daco said.
The US labor department is scheduled to release the latest CPI data at 8.30am.
The consensus forecast in a Reuters poll of economists has the index, excluding volatile food and energy prices, increasing at a 3% annual rate last month, slightly faster than in May.
That reading would likely leave the personal consumption expenditures (PCE) price index the Fed uses for its 2% inflation target far enough above that goal to keep the central bank’s benchmark interest rate in the 4.25%-4.50% range at the end of its July 29-30 policy meeting.
Investors expect the Fed to resume cutting interest rates in September, though US central bankers say any such move will hinge on how inflation and other aspects of the economy behave.
The final US tariff levels are not even fixed, with levels of 30% or more now threatened by Trump on Mexico, Canada and the EU, higher levies on autos and many industrial metals already in place, and more actions likely.
For the Fed, the way the process is unfolding feeds into concerns that the extended debate, policy reversals and uncertainty, and the potential for Trump to settle on higher levels than currently expected all add up to more inflation risk.
Clawing back tariff costs
The PCE index outside food and energy rose at a 2.7% annual rate in May; recent Fed policymaker projections see it hitting 3.1% by the end of 2025; and the most recent round of tariffs threatened by Trump for Aug 1 could push it even higher.
The new rates “if fully passed through, would add about 0.4 percentage points to the PCE price level,” Michael Feroli, chief US economist at JP Morgan, estimated.
“Given imperfect pass-through, margin compression, a more likely estimate is 0.2-0.3 points.
“We think this bolsters the case for the Fed to take a very cautious approach to rate cuts,” Feroli said.
Economists will be watching the data for signs of the pass-through to retail prices from tariffs imposed so far, most notably on goods from China, the third-largest US trading partner after Mexico and Canada.
Daco said there was already “divergence” beginning across a wide swath of goods where prices are rising faster than they did before Trump’s initial rounds of tariffs.
“One area that warrants watching for price acceleration is household furnishings,” he said. Prices of those products had been dropping, but reversed course in the spring.
Other economists have pinpointed different items that could show where the new import taxes are starting to hit consumer prices.
Omair Sharif, the head of Inflation Insights, said the broad category referred to as “recreational commodities,” which includes things like toys and audio and visual equipment that are often imported from China, also bears watching.
In his press conference following the June 17-18 policy meeting, Powell noted that electronics were an area where “we’re beginning to see some effects. And we do expect to see more of them over coming months”.
Outdoor equipment and tools are also items that are heavily imported, and the pace of their price increases picked up in the spring.
“Evidence suggests many retailers are hiking prices to claw back tariff costs,” wrote Samuel Tombs, chief US economist with Pantheon Macroeconomics, a trend that he estimates will help push the rise in CPI to 3% in June, a result that “likely will wipe out” any chance of a Fed rate cut later this month.