After three straight rapid monthly increases in the June quarter, US inflation data on Wednesday night was one of the key market events of the week.

A large surprise to the upside could have had material flow-on effects into other asset classes. But monthly inflation growth came in at 0.5%, in line with expectations.

Due to low base effects from 2020, annualised US inflation is still running above 5%.

But excluding food and energy items (which are deemed more volatile), monthly core inflation rose by only 0.3% which was below the consensus forecast.

The core CPI print lent weight to the argument that the outsized price increases, seen through the June quarter as the US economy reopened, may moderate as things return closer to normal.

For example, the Q2 monthly inflation jumps were driven by particularly sharp increases in specific sectors, such as used cars.

However, smaller gains in that component for July were cited by the US Labor Department as a key factor in the moderation of monthly growth.

US inflation and monetary policy

Given the Q2 buildup, it stood to reason that entrenched upward pressure on US CPI could change the assumptions underpinning the current liquidity settings adopted by the US Federal Reserve.

And analysts have been forming into two camps; those who think inflation is here to stay, and those who think it’s transitory.

In that context, the downside print for Q2 had the effect of “soothing nerves and easing tapering tensions from the back of investors’ necks”, said Jeff Halley, senior market analyst for OANDA foreign exchange group.

“With no US inflation shocks, the party continued on equity markets, with the rotation to growth continuing at a modest pace,” Halley noted.

Indeed, it’s been all calm on the stocks front this week, with the ASX 200 following Wall Street to continue its steady march to new record highs, despite the impact of COVID-19 lockdowns across half of the country.

So with an inflation breakout now considered less of a risk, what will the US central bank do next?

The July print seemingly removed any talk of interest rate rises earlier than the Fed’s current forecast of 2023.

Instead, focus in the near-term will centre around when it will start tapering its monthly bond-purchase program.

A Reuters survey of economists overnight showed a majority of respondents — 28 of 43 — expect the Fed to flag plans to start tapering its bond purchase program at its September meeting.

Currently, the bank is splashing out around US$120bn each month to buy US Treasuries (US$80bn) and mortgage-backed securities (US$40bn).

CBA takes the same view as the Reuters majority, with expectations for a September tapering announcement with the first rate hike in March 2023.

“To cajole some of the bears, the FOMC leadership may agree to delay implementation of the tapering until November or December,” CBA analyst Vivek Dhar said.

“But the market impact will be determined by the announcement, not the implementation.”