Has the Fed finished cutting rates?

That’s the central question facing most U.S. economy watchers. While U.S. Federal Reserve Board chairman Alan Greenspan is studiously avoiding any hints in his testimony before Congress today, data out this morning indicates that if the Fed isn’t done yet, it soon will be.

The U.S. Consumer Price Index was hotter than expected in June, up 0.2% on the headline rate, and 0.3% on the core rate (excluding food and energy). Economists were expecting a 0.1% rise on the headline and 0.2% on the core. “Although inflation has likely peaked and energy prices are easing, the sticky core inflation reading will make it more difficult for the Fed to continue cutting rates,” says BMO Nesbitt Burns Inc.

BMO notes that higher costs for food, housing, medical services, education, and tobacco are offsetting lower energy prices. Gas prices fell 2.6% in the month. “Apparel prices were also down, and have been falling steadily in recent months as retailers discount aggressively to stay competitive. Even so, core prices were up a higher-than-anticipated 0.3%. Core prices stand 2.7% higher year-over-year, up slightly from a month ago. Housing, medical care and tobacco contributed to the monthly increase in core prices, and are keeping year-on-year core inflation stubbornly high.” Although it notes that as capacity utilization has dropped sharply, core inflation pressure should soon begin to ease.

If higher-than-expected inflation is likely to keep the Fed from further cuts, persistent strength in the housing market may render further cuts unnecessary. U.S. housing starts jumped a higher-than-expected 3% in June as lower mortgage costs lured buyers and the backlog of orders at builders remained high. Starts are now at their second highest level this year. “With the second-quarter average of 1.63 million units essentially unchanged from Q1, these results show that the demand side of the economy is still perking along nicely,” says BMO.

BMO suggests that start activity may soon weaken, reflecting lower building permits, as labour markets weaken too. However, it says homebuilders remain moderately optimistic. “In contrast with yesterday’s gloomy factor sector report, today’s numbers show that construction remains a bright spot on the economic landscape. The current level of starts is underpinned by low borrowing costs, but maintaining this robust pace will prove difficult unless payrolls return to the positive side of the ledger.”