US July inflation likely steady as Fed faces battle to justify higher rates: RBC

Investing.com -- U.S. inflation data due later this week is likely show that inflation "held steady" in July, RBC estimates, underpinned by a narrowing source of price pressures just as the Federal Reserve faces an "increasingly difficult" task to justify higher for longer interest rates.

"We expect further signs of easing inflation in July," RBC said, forecasting the headline price growth held at 3% on an annual basis but with a second straight small 0.1% monthly increase in core (excluding food and energy) prices.

"That should reassure the Fed that those annual rates will continue to move lower," it added, as factors putting upward pressure on inflation have narrowed. 

The Labor Department is set to release consumer price index for July on Wednesday at 08:30 EDT.

Home rents, which make up a "disproportionate share of the remaining annual price growth," RBC adds, is slowing as the impact of "earlier easing in market rent increases eventually passes through to lease agreements."

On the economic front, there's little to suggest that the Fed should hit the panic button in the wake of rent jobs-led growth scare, but the U.S. central bank's higher for longer rate regime is becoming difficult to justify. 

"Evidence is building that broader economic conditions have already normalized and inflation is more likely to drift lower," RBC said. The case for the Fed to justify keeping rates at more than 200 basis points above its own estimate of the long-run 'neutral' rate' is becoming "increasingly difficult."

The Fed believes the current neutral rate, one that neither boosts nor holds back economic growth, is 2.5%, which is nearly 300 basis points below the current rate of 5.25% to 5.5%, or 5.375% at the midpoint.

While a 25 basis point cut is priced in for September, RBC believes the "risks of a larger cut are contingent on further downside in economic growth or inflation surprises."