The Weekly Bottom Line

It was a week full of surprises, with inflation being the key theme. Chief among them was the U.S. Senate quickly moving to pass the Inflation Reduction Act of 2022 (IRA). It now heads to the House of Representatives later today for a final vote, where it’s expected to pass. The reconciliation bill is a significantly scaled back version of the far more ambitious Build Back Better Act, though it still incorporates many of the key climate related initiatives that were included in the previous bill.

In terms of broad strokes, the IRA aims to spend roughly $430B on climate and healthcare initiatives over the next decade and is estimated to more than offset those expenditures with $740B of proposed revenue. Over 85% of the appropriated expenditures will be directed towards climate related initiatives and will be dispersed mainly through grants and loans. Of those investments, perhaps most noteworthy is the $80B in new rebates allocated to eligible households for electric vehicles (EVs) and to help decarbonize residential buildings. The additional funding for EVs not only maintains the existing $7,500 rebate but also introduces a new tax credit of up $4,000 for both used and new EVs, with the latter applying only to those vehicles made in North America. 

On the healthcare side, the IRA will put a cap of $2,000 on out-of-pocket prescription drug costs for individuals on Medicare. It also aims to bring down the cost of the most expensive drugs by allowing the government to negotiate the price of a subset of those drugs covered by Medicare, though this won’t start until 2026.

All of this will be paid for through a new 15% minimum corporate tax imposed on corporations earning more than $1B, enhancements to the IRS audit and review process, and taxing share buybacks. The fact that the deficit will be reduced over the next decade is what is being used to justify the “inflation reduction” element of the bill. However, the total deficit reduction is only estimated to be $400B (or 1.6% of GDP), and will be spread over the next decade – suggesting the impact to growth and inflation will likely be negligible.

Turing to the other surprise this week, July CPI data (finally!) came in weaker than expected. The headline index was flat on the month, while core prices “only” rose by 0.3% m/m (Chart 1). Indeed, the recent pullback in energy prices subtracted from the headline measure, though accelerating food prices provided a partial offset. Looking to the core measure, there were a few encouraging tidbits. Core services grew by 0.4% m/m – down from the 0.7% m/m reported in June. A lot of the pullback was the result of a softening in travel-related categories, such as airfares, car rentals, and lodging away from home (Chart 2). Other green shoots emerged on the goods side, as prices across most categories decelerated, while used vehicle prices, apparel, and education goods all declined.  

This will be welcome news to FOMC officials, but as San Francisco Fed president Mary Daly said on Wednesday “it’s still too early to declare victory”.  Daly reiterated her support to dial back on the pace of rate hikes in September but didn’t rule out another 75bps move should the turn in inflation prove to be fleeting.

Thomas Feltmate, Director | 416-944-5730