New inflation reading creates dilemma for Fed over cutting rates in September

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.