Citigroup: The transmission of tariffs to inflation is slower and more persistent than expected, and the next few months will be a key verification period

Citigroup's latest inflation weekly report shows that the impact of tariffs on consumer prices has indeed occurred, but it has manifested in a slower and more persistent form than the market expected.

According to the news from the Chase Trading Desk, Citigroup stated in its latest research report that the worst-case "inflation blitzkrieg" (i.e., a rapid and comprehensive surge in prices) has been temporarily avoided, but this may indicate that a more sticky inflation pressure is forming, which will gradually erode corporate profits and ultimately be passed on to consumers.

The next few months (August to October) will be a critical window to verify this trend. Investors need to closely monitor price movements in categories such as clothing, automobiles, and electronics, as seasonal factors and cost transmission chains suggest that prices in these areas may experience "abnormally strong" increases. Citigroup predicts that as a result, the core Personal Consumption Expenditures (PCE) price index may reach 3.2% in the fourth quarter of 2025, and the inflation alarm is far from being lifted.

Tariff transmission unexpectedly slow, but "worst-case scenario" avoided

Despite multiple rounds of tariff increases implemented by the U.S. since spring, its direct driving effect on consumer goods prices in the inflation data over the past 4-5 months has been much smaller than expected. Although the inflation data in July showed some strengthening (core CPI monthly growth of 0.3%, in line with expectations), its main driving force came from the service sector rather than goods. Citigroup expects a month-on-month growth of 0.27% for core PCE in July, with the annual rate rising to 2.9%.

The report clearly states that the "worst-case scenario" that the market is concerned about—namely, a rapid, large-scale, and widespread increase in goods prices due to rising expected costs—has been avoided.

The core reason lies in weak end demand. Against the backdrop of sluggish demand, companies are forced to absorb tariff costs over a longer period to avoid losing customers due to significant price increases. While this strategy has temporarily suppressed CPI data, the cost is that corporate profits are squeezed, which may further drag down future total demand. Therefore, the impact of tariffs has not disappeared but has been extended over time.

The next few months are a key window: focus on clothing, automobiles, and electronics

Citigroup emphasizes that the inflation data from August to October will be the "greatest test" of the tariff transmission dynamics. The framework of the bank indicates that the risk of price increases for goods during this period has significantly increased, mainly based on the following points:

• Seasonal increase in clothing prices: Historically, August and September are traditional periods for the clothing industry to raise prices in anticipation of the new season.
• Seasonal reversal in automobile prices: The seasonal factors for new and used car prices will shift from negative to positive, which will itself support prices, compounded by the impact of tariffs
• Signal of Rising Prices for Electronic Products: In July's Producer Price Index (PPI), there was a significant increase in the prices of household electronic devices. This strongly suggests that consumers may face more pronounced price increases for video and audio products in the coming months.

Although Citigroup slightly lowered its forecast for future commodity prices due to slow transmission in previous months, its model indicates that core commodity prices will remain "exceptionally strong" in the coming months.

The report, through an analysis of import price data, found that the phase where exporters "foot the bill" for tariffs seems to have ended. Data shows that during the period from March to May, the import prices of goods such as clothing and home goods decreased, indicating that some exporters initially absorbed the tariff costs.

However, recent data shows that the import prices of home goods have stabilized, while the import prices of clothing have risen again. This indicates that exporters, after going through a brief "grace period," are no longer continuing to absorb tariff costs. As importers begin to bear higher tariffs from shipments in June and July, this cost pressure is likely to be passed on to final consumers in the fall, laying the groundwork for inflation data at that time.

Service Sector Inflation: Appears Strong, but Driven by a Few Items

The strong performance of service sector prices in July can easily raise market concerns about a broad-based rise in inflation. However, Citigroup's in-depth analysis suggests that this is not a widespread price pressure.

Specifically, the rise in CPI service prices is mainly driven by two "one-time" factors: a significant increase of 2.6% in dental service prices and a seasonal rebound in airfare prices. Similarly, the core PPI service price increase of 0.7% is primarily due to a substantial rebound of 5.8% in portfolio management fees linked to asset prices. Citigroup believes that the spikes in these specific items are not sustainable and do not represent a comprehensive return of service sector inflation pressure.

The preliminary survey from the University of Michigan in early August showed that inflation expectations have risen again (1-year up to 4.9%, 5-10 years up to 3.9%). However, Citigroup is cautious about this, believing that the increased volatility in the data after the methodological change in the survey warrants a reduction in reference weight.

Nevertheless, one detail in the survey has raised Citigroup's alert: the proportion of consumers who believe "it's not a good time to buy large household items due to high prices" has jumped for the first time this year. Citigroup believes this could be an important signal, suggesting that consumers have begun to feel the pressure of rising prices more noticeably in August. While this may not lead to a buying spree (as the proportion of consumers purchasing in advance due to expectations of higher future prices is declining), it aligns closely with Citigroup's expectation that price increases will become evident in the fall, warranting close attention from investors