The dollar has risen ahead of the key US inflation report due later on Wednesday. The US Consumer Price Index (CPI) reading for August is expected to have increased by 0.6% last month, according to a Reuters survey of economists. The release will come just a week before the Federal Reserve (Fed) interest rate policy. The central bank is largely expected to keep rates on hold at next week’s meeting, according to CME’s FedWatch Tool. However, it is uncertain what the Fed’s next move will be in its next meeting in November.
Federal Reserve expectations
If inflation comes in line with expectations or even below then analysts expect the Fed to have reached the end of the rate cut cycle. However, if inflation figures come out higher, then this will support the hawkish sentiment and will open the possibility for further monetary tightening through the end of the year 2023. Such an expectation for higher interest rates and for an extended period will help offer support to the US dollar.
US CPI in detail
The highly-anticipated US Consumer Price Index (CPI) inflation data for August will be published by the Bureau of Labour Statistics (BLS) on Wednesday at 12:30 GMT. The US Consumer Price Index is forecast to increase 3.6% YoY in August, up from the 3.2% rise recorded in July. Core CPI inflation is expected to drop to 4.3% YoY in August. The report is very important as it could influence the exchange rate of the greenback ahead of the Fed’s September policy meeting.
In July and August, rising energy prices impacted inflation and this is anticipated to be reflected in the August CPI increase. While markets tend to focus on the core inflation figures which do not include the price changes in volatile items such as food and energy, the Fed will take into account the increase in energy costs when setting its policy. A stronger-than-expected rise in the CPI could strengthen expectations for a hawkish Fed, even if the Core CPI eases slightly.
Investors will closely analyse the details of the report to see if there is progress in controlling high inflation. According to the CME Group FedWatch Tool, markets are pricing in a 40% probability of the Fed raising the policy rate by 25 basis points (bps) before the end of the year.
A higher-than-forecast rise in the monthly CPI could confirm one more Fed rate hike in November or December and support the USD. However, on the other hand, the USD could weaken if the CPI prints come lower than expected. In this scenario, markets may initially react by triggering a capital outflow out of the USD. At the same time, and ahead of next week’s Fed policy announcement, investors may choose not to bet on a persistent USD weakness and remain cautious.