Originally Published: 10 AUG 23 08:36 ET

Updated: 10 AUG 23 12:20 ET

By Alicia Wallace, CNN

Minneapolis (CNN) — For the first time in more than 12 months, the pace of consumer price hikes accelerated on an annual basis.

The Consumer Price Index rose 3.2% for the year through July, up from June’s 3% annual increase, according to data released Thursday by the Bureau of Labor Statistics.

The annual headline rate’s increase, which was largely due to year-over-year comparisons to July 2022 when monthly inflation turned negative, came in below economists’ expectations for a 3.3% annual gain.

Prices rose 0.2% on a monthly basis, driven by shelter costs, which accounted for 90% of the increase, the BLS report said.

“Don’t be fooled by the uptick in [year-over-year] inflation,” said Julia Pollak, chief economist with employment site ZipRecruiter, in commentary issued Thursday. “Inflation is slowing and doing so across a broader range of goods and services.”

Continuing to cool

Despite the uptick in the headline number, the July report showed that underlying inflation continued its cooling streak.

Core CPI, which excludes the more volatile food and energy prices, increased 0.2% from June and was up 4.7% from the year-ago period. July is the the fourth consecutive month that annual core CPI has eased, and the 4.7% rate landed 0.1 percentage points below consensus expectations. Declines in used car prices as well as airfares helped to bring core CPI lower.

In June, prices increased 0.2% for the month and 4.8% annually.

President Joe Biden on Thursday said the latest CPI report shows the US economy “remains strong.”

“Annual inflation has fallen by around two thirds since last summer, and inflation outside of food and energy has fallen to its lowest level in any three-month period since September 2021,” Biden said in a statement issued Thursday morning after the report was released.

“We’ve made this progress while maintaining the broad strength of our economy: Unemployment remains near record lows, a higher share of working age Americans are working now than in 20 years, real wages for the average American worker are growing and are higher than they were before the pandemic — with lower wage workers seeing the largest gains,” he said.

Persistently high inflation — specifically grocery, gas and rent prices — has weighed on Americans for more than two years. Since March of last year, the Federal Reserve has raised interest rates 11 times to the highest level seen in 22 years in hopes of reining in inflation by tempering demand.

“The July 2023 report’s core CPI result should reinforce the view that the Fed can begin to rely more heavily on hawkish rhetoric than on further interest rate hikes,” wrote Kurt Rankin, PNC senior economist, in a note Thursday. “This approach can make clear that the Fed will not allow inflation to reignite and that policy will remain restrictive in the face of strong consumer demand and wage growth but that past action can be allowed to continue to do the work that now appears to be bearing fruit.”

The markets seemed to agree: The probability of the Fed holding steady at its September meeting increased 4 percentage points to around 91% on Thursday, according to the CME FedWatch Tool.

US indexes moved higher on the news as well. The Dow, S&P 500 and the Nasdaq were each up about 1% after the report was released but have since settled slightly.

More cooling on the horizon

While an upward swing after a year’s worth of cooling could be anxiety-inducing, economists say an uptick doesn’t necessarily signal a return to the decades-high inflation rates of last year.

“Going forward, I really think you’re going to see relief, vis-à-vis the core estimate of inflation, around rents, new vehicles and used vehicles,” Joe Brusuelas, principal and chief economist for RSM US, told CNN.

The shelter component of CPI is a lagging indicator of rents, which current market data shows are on the decline. Those decreases are expected to manifest in the data in the coming months, and new forecasts from the San Francisco Fed suggest a severe contraction will occur next year.

Shelter prices rose 0.4% month on month and were up 7.7% for the year ending in July. The annual shelter inflation rate has now eased for four consecutive months.

Excluding shelter, services inflation was up 0.2% on the month, unchanged from June’s rate, and is up 3.3% year over year, BLS data shows.

The Fed has keyed in on this “supercore” category to see how heavily price increases are influenced by the cost of labor. Inflation within that category has a greater potential to be “sticky” because labor costs play a heavier role in services businesses, and those costs don’t come down as quickly.

Services sectors are continuing to see some of the largest price increases, including car repairs, which are up 19.5%; fees for lessons are up 14.2%; and veterinary services are up 10.6% annually, BLS data shows.

Used and new car prices will continue to cool now that pandemic-era supply chain pressures and shortages have eased, Brusuelas said.

Prices are still running hot, they’re not as bad as they were this time last year, when grocery prices spiked to 13.1% on an annual basis and gas prices were 44% higher than they were in July 2021.

As of last month, the pace of those increases has calmed considerably: Food-at-home prices were up 3.6%, gas prices were down nearly 20% but up 0.3% and 0.2% on a monthly basis.

Real wage gains continue, but there are clouds ahead

A key difference this time around, however, is that inflation has finally tailed off enough where it’s not fully devouring people’s wage gains.

In July, real (inflation-adjusted) average hourly earnings increased for the third consecutive month, rising 1.1% from June, BLS data shows. Prior to May 2023, real earnings growth had been negative since March 2021.

“For the consumer, what they’re looking at is, ‘What is the price of gas at the pump?’ What are the prices of eggs or milk?’” Tamara Charm, a McKinsey partner who studies consumer sentiment, told CNN. “Given they’re so much lower than last year, I think that’s why we’ve seen confidence start to come back.”

Closely watched measures of consumer confidence and consumer sentiment have trended higher in recent months amid waning inflation and a resilient labor market.

That being said, people aren’t spending like they were last year, she said.

“And certainly not like they were a year and a half ago, before inflation hits,” she added. “So I think consumers are concentrating on what they can see in front of them.”

With the persistent whispers of impending recession warnings in the back of their heads, consumers continue to trade down on a broad array of items while opting to splurge on some out-of-home experiences, she said.

Consumer spending is the engine behind the economy, and that is typically fueled by “loose and cheap and abundant debt,” said Danielle DiMartino Booth, chief executive officer and chief strategist of Quill Intelligence and former adviser to the Federal Reserve Bank of Dallas.

And in recent months, debt levels have grown, high interest rates have made them more expensive and credit is getting harder to come by.

The wave of large corporate bankruptcies also could spell trouble ahead, DiMartino Booth said.

“Large company bankruptcies north of $50 million in liability are running at the fastest pace since 2010,” she said. “So at some point, you’re going to start to see that show up in the data. And if there are fewer individuals collecting incomes, that is going to be your strongest deflationary force.”

-— CNN’s Elisabeth Buchwald contributed to this report.