Aug 26 (Reuters) – Annual U.S. inflation unexpectedly held steady in July well above the Federal Reserve’s 2% target for the 65th straight month, and the pause in the decline from a recent war-induced peak is likely to intensify the central bank’s debate over whether interest rates should be lifted or held steady.
The Personal Consumption Expenditures Price Index increased 3.7% in the 12 months through July, unchanged from June, the Commerce Department’s Bureau of Economic Analysis said on Wednesday. Economists polled by Reuters had forecast a reading for PCE, which the Fed uses to set its target, of 3.6%.
The month-over-month figure also came in higher than expected at 0.2% in July after falling 0.1% in June, which had been the weakest reading since April 2020. Economists had forecast a 0.1% increase.
Excluding energy and food prices, so-called core PCE — which Fed officials use as a guidepost for inflation’s underlying run rate — held steady at 3.3% on the year while rising to 0.2% on the month from 0.1% in June.
The above-forecast headline print gave a modest lift to expectations that the Fed may raise interest rates as soon as next month. Fed funds futures prices reflected about a 42% probability of a rate hike at the central bank’s September 15-16 meeting after the report, versus about 36% immediately before.
“This is data that supports a hike,” said Omair Sharif, founder and president of forecasting firm Inflation Insights. “The unrounded core PCE was 0.246%, so it barely missed out on rounding to 0.3%. That is a one-month annualized rate (of) nearly 3.0%.”
WAR AND TARIFFS CLOUD INFLATION OUTLOOK
Annual PCE shot to a three-year high of 4.1% in May in rapid fashion after President Donald Trump launched air strikes along with Israel against Iran in late February, sending energy prices spiraling upward as the conflict shut in roughly a fifth of global oil supplies.
Six months later the conflict appears no closer to a final resolution, though the exchange of fire has diminished and oil prices and the wider inflation wave they instigated have retreated from their mid-spring highs.
The slowdown in inflation in the last two months has helped buoy the arguments of the majority of Fed policy committee members who voted last month to leave the central bank’s benchmark interest rate unchanged in the 3.50%-3.75% range, where it has been since December. But the sluggish pace of improvement is unlikely to mollify a growing minority of Fed officials who argue tighter policy is needed, given that inflation has been above target since February 2021 and will not get to the 2% level without further restraint.
Inflation as measured by PCE peaked at 7.2% in June 2022, and the steepest Fed rate increases since the 1980s helped put it on a path back toward 2%. That trajectory changed last year after Trump unleashed a wave of import tariffs upon his return to the White House, sending a wide range of goods prices higher, with the Iran war exacerbating those pressures.
And new tariff-induced pressures are likely coming, after trade negotiations between the U.S. and its second-largest trading partner, Canada, fell apart on Friday, resulting in new levies on $20 billion of Canadian imports to go into effect. Since then, Washington and Ottawa have each announced additional retaliatory measures to go into effect in coming months unless a deal is reached to avert them.
The BEA on Wednesday also updated data for economic growth for the second quarter, leaving unchanged its estimate of annualized gross domestic product growth at 1.5%. Among the notable changes from the first estimate was an upward revision to consumer spending during the April-through-June period to 3.4% from the originally reported 3.2%, an indication that the individual consumption that supports two-thirds of U.S. economic activity had held up through the first half of the year.
(Reporting by Dan Burns, Michael S. Derby and Ann Saphir; Editing by Chizu Nomiyama and Paul Simao)
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