A fresh reading on inflation showed tariffs are pushing goods prices higher for Americans, creating a dilemma for the Federal Reserve of whether to hold interest rates steady in September.
The Consumer Price Index for the month of July showed prices rose 3.1% year-over-year excluding volatile food and energy prices. That was hotter than the 3% economists expected and up from 2.9% in June when inflation was pushed higher by rising goods prices. Month over month CPI clocked in as expected, rising 0.3%.
Though, on a headline basis, CPI rose less than expected—by 2.7%, a tenth lower than expectations for a rise of 2.8%.
“There was another narrative shift for the Fed to contend with in the July CPI data, with tariff effects once again barely perceptible but a stronger gain in services prices pointing to another above-target gain in the core PCE deflator last month,” said Stephen Brown, deputy chief North America Economist for Capital Economics.
But Brown noted that given that several members of the Fed are now more worried about the outlook for the job market, this inflation report probably won’t be enough to prevent the Fed from cutting rates sooner than he previously expected.
“But it does support our view that markets are overestimating the degree of loosening to come over the next 18 months,” he said.
The Fed has been largely in a “wait and see” mode, as many central bankers want to assess the impact of tariffs on inflation.
Fed Chair Powell has said he wants to see what the impact of tariffs are on inflation over the months of June, July and August, though he’s coming around to the idea that their impact may be no more than a one-time increase in prices. But as the Fed waits to see whether or not tariffs will lead to persistent inflation, July’s inflation data didn’t offer any decisive findings with some areas of goods inflation like furniture and shoes perking up, but services inflation, which has been the stickier culprit historically, popping back up.
Inflation now stands more than a full percentage point above the Fed’s 2% target.
“This month’s report did nothing to convince anyone,” said Chris Zaccarelli, Chief Investment Officer for Northlight Asset Management.
The inflation data come after a government report showed the US economy added just 73,000 jobs in July, while the unemployment rate moved up to 4.2% from 4.1% the month prior. At the same time, the two prior months saw downward revisions. May’s job gains were revised down to 19,000 from 144,000, while June’s additions were cut to just 14,000 from the 147,000 initially reported. That pulled the three-month average employment gain down to 35,000 — a figure many analysts are interpreting as a sign that hiring is stalling, even as population growth slows.
The data is likely to lead to continued division within the central bank over whether to cut rates in September at this juncture.
In recent days, more Fed officials, including San Francisco Fed president Mary Daly and Minneapolis Fed president Neel Kashkari have made comments that set the table for cutting rates as soon as next month, citing concerns over a weakening job market.
“The labor market has softened. And I would see additional slowing as unwelcome, especially since we know that once the labor market stumbles, it tends to fall quickly and hard,” Daly said in a speech in Alaska last week. “All this means that we will likely need to adjust policy in the coming months.”
Federal Reserve governor Michelle Bowman said Saturday that she is looking at three interest rate cuts this year, citing concerns she sees a risk that further delays in cutting rates could “result in a deterioration in labor market conditions and a further slowing in economic growth.”
Meanwhile, other members of the Fed like Atlanta Fed president Raphael Bostic and Cleveland Fed president Beth Hammack are more concerned about inflation. While both have showed concern with the last jobs report, they are still focused on inflation with Bostic retaining his estimate right now for only one rate cut this year.
Markets are pricing in a 90% chance the Fed cuts rates by 25 basis points in September.
Jennifer Schonberger is a veteran financial journalist covering markets, the economy, and investing. At Yahoo Finance she covers the Federal Reserve, Congress, the White House, the Treasury, the SEC, the economy, cryptocurrencies, and the intersection of Washington policy with finance. Follow her on X @Jenniferisms and on Instagram.