Fed likely to hold rates steady in September as inflation cools

Federal Reserve policymakers are likely to keep interest rates unchanged at their September meeting after fresh data showed inflation easing for a second consecutive month. The Consumer Price Index rose 3.4% in July from a year earlier, down from 3.5% in June, matching economists' forecasts. Core inflation, which strips out volatile food and energy prices, slowed to 2.5% year-on-year from 2.6% the previous month.

However, beneath the headline numbers, some analysts see signs that price pressures remain broad-based. A sharp drop in hotel prices, which is unlikely to persist, accounted for much of the monthly easing in core inflation. Meanwhile, more categories of core goods saw price increases than in June, and technology prices jumped on strong demand linked to artificial intelligence.

Gasoline prices fell, pulling down overall inflation. But global fuel prices have risen again this month as tensions in the U.S.-Iran conflict simmer. The Strait of Hormuz, which handled a fifth of the world's oil shipments before the conflict began in late February, remains largely closed.

The Fed targets 2% inflation as measured by the Personal Consumption Expenditures Price Index. Analysts estimate that even with the slowdown in year-over-year CPI, the Fed's preferred core PCE measure is still on track to be slightly above 3%.

Fed policymakers voted 9-3 last month to keep the benchmark rate in the 3.50%-3.75% range, where it has sat since December. Since then, the three dissenters and a couple of regional bank presidents without a vote this year have argued for a hike given still-elevated inflation.

New York Fed President John Williams has said he expects inflation to continue easing as the effects of last year's tariff increases and the Middle East war fade, allowing the central bank to hold rates. Fed Chairman Kevin Warsh has offered little guidance on what would prompt a policy change.

"Without forward guidance, the September decision will likely remain a close call until the very end," said Olu Sonola, head of U.S. economics at Fitch Ratings. "It will not be a slam dunk: whether it is a hold or a hike, both hawks and doves will find enough in the data to make their case."

After the latest CPI data, traders increased bets on no change in rates at the Fed's September 15-16 meeting, a view that gained traction last Friday after a report showed the economy unexpectedly lost jobs. Still, markets price a 38% chance of a hike next month and remain convinced the central bank will need to raise rates by the end of 2026 to tame inflation that has exceeded the 2% target for over five years.

"The Fed will need to see more evidence in future inflation reports that core services inflation is truly moderating before they take their rate hike threat completely off the table," said Scott Anderson, chief U.S. economist at BMO Capital Markets.