July CPI Report: What You Need to Know

The gist: Today's inflation report held more bad news for the economy: Consumer prices in July jumped twice the expected rate and hit a 17-year high, a hint that inflation pressures aren't cooling even as the economy struggles. The Labor Department's Consumer Price Index rose 0.8 percent in the month, pushing year-over-year prices up 5.6 percent, the highest rate since Jan. 1991.

Record energy costs are behind much of that increase, and some economists hope the recent pullback in oil prices might translate to a slower rise in inflation in coming months. Still, it appears the long-term effects of record costs for gasoline (up 4.1 percent in the month) and food (which now costs 6 percent more than a year ago) are finally hitting consumers.

For example, clothing prices rose 1.2 percent month-to-month, a 10-year high. Airfares jumped 1.3 percent because of high fuel costs. Recreation costs rose 0.4 percent in the month. Excluding food and energy, the core CPI rose 0.3 percent for a second straight month. That measure, favored by the Federal Reserve because it's seen as less volatile, is now 2.5 percent above a year ago—a full half-point above the Fed's "comfort zone" for inflation.

What it means: These are exactly the sorts of numbers that worry investors. Higher inflation means the Federal Reserve could be forced to hike interest rates sooner rather than later. The combined pressures of a weaker job market (new jobless filings released today are still at recessionary levels) and higher prices adds to fears that consumer spending might falter. That's a big concern now, as shoppers head into the all-important fall months that include both the back-to-school and holiday shopping periods.

Economists' reactions: Global Insight's Kenneth Beauchemin: "Now that the tidal surge in energy and other commodity costs is showing unmistakable signs of turning up in consumer prices at large, the Fed finds itself pushed further into the corner. The recent report on retail sales coupled with today's report indicates that a dip in real consumer spending is now underway. The Fed is in the same uncomfortable position as it has been for months—caught between a weak economy and elevated inflationary pressures—only more so. Facing heightened pressures from both sides, we continue to expect the Fed to hold the fed funds rate at 2.0% into 2009."

Goldman Sachs economists called the CPI report "horrible" but noted that the drop in crude prices should slow the advance of energy-related inflation. They write: "The energy piece of this is quite likely to moderate in coming months given the developments in crude oil and gasoline prices (though part of that is seasonal). The food should also slow, but the timetable for this is less certain."

Michael Woolfolk, senior currency strategist at Bank of New York Mellon, says the decline in energy costs in recent weeks may do much to help offset rising prices. He writes: "While the drop in crude oil prices should push gas prices lower at the pump, earnings are under pressure and gas companies are likely to try and widen margins. At the same time, while the drop in commodity prices should push food prices lower at the grocery store, import prices have soared this summer and food manufacturers are likely to try and exercise some pricing power for the first time in a while. What this means is the decline in crude oil and commodity prices does not guaranteed a comparable improvement in inflation figures."