Back-to-back hotter-than-expected inflation readings may disappoint Federal Reserve officials who anticipated price pressures would ease on their own, potentially leading to an interest-rate hike at the central bank's meeting next week and possibly more thereafter.
Inflation excluding energy and food, a key measure of underlying price trends, rose 0.3% last month, according to data from the Bureau of Labor Statistics. This figure exceeded the 0.2% anticipated by economists. Annually, core consumer price inflation increased by 2.4%, while overall consumer inflation stood at 3.4%.
This latest inflation data, combined with a stronger-than-expected producer price index released Thursday and oil prices that have surpassed $100 a barrel due to renewed hostilities in the Middle East, suggests that inflation—which has been above the Fed's 2% target for five and a half years—is moving in an unfavorable direction.
Fed Chairman Kevin Warsh has stated that he and his colleagues may need to take action if they lack confidence that underlying inflation is moving toward the 2% target "clearly and at sufficient speed." Economists analyzing Friday's data indicated that the current figures do not appear to meet this threshold.
"Today’s clean 0.3% core CPI print, combined with the sharp rise in energy prices and persistent tensions with Iran, all but locks in a Fed rate hike next week," wrote Seema Shah, chief global strategist at Principal Asset Management. "After half a decade of above-target inflation, policymakers are likely to conclude that more than one hike will be needed to re-establish price stability."
The Federal Reserve has maintained its policy rate within the 3.50%-3.75% range throughout the year. This stance was reflected in a 9-3 vote in July, which indicated growing sentiment within the Fed that higher rates were necessary.
At last month's annual gathering of the Kansas City Fed in Jackson Hole, Wyoming, Warsh reiterated that the central bank might need to act if confidence in inflation's downward trajectory toward 2% was not established.
Omair Sharif, founder of Inflation Insights, commented, "For the Fed, it is time to put up, or shut up." He added, "You cannot give a speech like you did at Jackson Hole and not support a rate hike at the next meeting. You will either have to back up those words or end up as the boy who cried wolf."
However, not all economists share this view. The Fed's inflation target is based on the 12-month change in the personal consumption expenditures (PCE) price index, which weights certain items differently than the CPI. For example, prices for some AI-related goods are weighted more heavily in the PCE. Data for August showed that software and accessories prices declined, and core goods prices decelerated. Oxford Economics analysts estimate that core PCE for August likely rose a "benign" 0.2%, which could allow the Fed to forgo a rate hike next week. They described the decision as being on a "knife’s edge."
Several other economists project a higher core PCE reading, which they believe could increase concern among Fed officials who had anticipated that cooling inflation in June and July signaled a positive trend. At least two Wall Street firms now forecast a rate hike next week, having previously expected the Fed to hold rates steady.
"This call reflects the inflation data, but also the market expectations as Chairman Warsh will want to avoid a dovish surprise next week," wrote analysts at Piper Sandler.
Traders of short-term interest-rate futures are currently pricing in approximately an 85% chance of a quarter-point increase at the Fed's September 15-16 meeting, up from about 70% before the report. Market pricing also suggests expectations for a second rate hike in December.
"We don’t think today’s print portends a reacceleration of core inflation, but merely a bump on the disinflationary road," wrote Christopher Hodge, an economist at Natixis. "We think a nudge via a hike or two is probably what the Fed will think is appropriate, starting with a hike next week."