With the U.S. government bailing out Fannie Mae and Freddie Mac last week, followed by Lehman Brothers filing for bankruptcy and Bank of America purchasing Merrill Lynch on Sunday, Tuesday's CPI release from the Bureau of Labor Statistics promises to be highly anticipated. Many believe the data could have some influence in the central bank's rate decision just hours after the inflation data are released.

"The FOMC will pay very close attention to CPI on Tuesday," said Ken Beauchemin at Global Insight. "Their primary mandate, so to speak, is price stability, and they're keenly interested in CPI especially given elevated core readings in last couple months."

"CPI certainly could tip the balance," he added, "a +0.3% on core would certainly activate the more aggressive-on-inflation members. It is enough influence the dynamics of the meeting."

Although Global Insight is expecting another three-month consecutive 0.3% month-over-month rise in core CPI, the consensus is looking for a 0.2% month-over-month increase in August following July's gain, with the annual figure ticking up one tenth of a percentage point to 2.6%.

4Cast economist David Sloan, who expects a 0.2% increase in core CPI on Tuesday, said, "If the Fed is contemplating any easing in response to the latest outbreak in financial markets they will have to pay close attention to the inflation figure, but we don't think the CPI will make or break the FOMC's decision."

"We don't expect them to be easing tomorrow, and if CPI came in high, it would make it harder to do so."

On the headline, the consensus expects falling commodity prices, and deteriorating demand in the United States to translate into a 0.1% month-over-month decline in consumer prices, sharply opposed to July's 0.8% increase. Meanwhile, annual headline inflation is projected to fall to 5.5% from 5.6% previously.

"A slumping global economy has crushed commodity prices, in turn pushing down market-based measures of inflation expectations," explained Richard Berner of Morgan Stanley. "In our view, headline inflation will come down by half over the next year, but fears that yesterday's inflation surge will morph into deflation or even severe disinflation are wildly overblown. On the contrary, courtesy of lingering global inflation pressures, inflation is unlikely to decline below 2% any time soon."

A report from Goldman Sachs agrees with the assessment saying, "Although consumer price inflation accelerated to 5½% over the past year, fanning inflationary fears, the tide has now turned. Commodity pressures have eased, asset prices continue to decline, spare capacity remains high, constraints on growth have tightened, and inflation expectations have come off the boil."

"Deflation, in a technical sense, is conceivable in the coming year. We now expect core CPI inflation to slow to 1.9% on a year-over-year basis by the end of 2009 (versus 2.1% previously)," the report goes on. "If oil prices were to remain at current levels, headline inflation would drop below 1% in July 2009; further declines could result in an outright decline in the CPI over this period."

On the market side of things, Mark Frey, vice-president of FX trading at Custom House said he is not expecting U.S. CPI to have much of an impact on markets tomorrow, saying the inflation figures wouldn't stop the Fed from cutting rates to create some confidence in the market.

Although Frey said he is not expecting the Fed to cut rates, it won't be based on inflation concerns. "I think all the data is going to be taking a back seat to the events. Yes you might get some short term chop and volatility from it but no one is trading data, they are trading events."

4Cast's Sloan disagreed saying that "If we got a soft number [in inflation], those hoping for a rate cut would be more at ease with pricing a rate cut ahead of the meeting, and a real upside choker could hit equities."

The Fed's rate decision comes at 2:15 p.m. EDT, and the consensus currently looks for the FOMC to leave the Fed Funds Rate unchanged, while Fed Fund Futures suggests markets are pricing a 74% chance of a 25 bps cut.

By Erik Kevin Franco and edited by Megan Ainscow
©CEP News Ltd. 2008