Firm Inflation Reading Keeps Pressure on Fed to Raise Rates -- 4th Update

By Justin Lahart and Matt Grossman

The annual inflation rate stalled out last month, with Americans still paying high prices for gasoline. The report could put more pressure on a Federal Reserve that has been sharply divided over whether it should raise rates at its meeting next week.

The Labor Department said Friday that the inflation rate held steady at 3.4% in August. That matched analyst expectations and was even with July's 3.4%. A key measure of underlying price trends, however, came in stronger than expected.

What this means for the Fed

Markets now see a rate increase next week as very likely. Interest-rate futures now imply there is about an 85% chance that the central bank will increase its target range on overnight rates by a quarter point. Before the report, the chances were about 70%.

"If you don't raise rates now you better have a damn good story on why you didn't," said Omair Sharif, head of advisory firm Inflation Insights.

Fed policymakers have been sharply divided over whether they should raise rates at their policy-setting meeting next week. At the Fed's last meeting, in July, three officials dissented in favor of raising rates, and others have since said they could join them if inflation doesn't improve.

Further complicating the Fed decision, oil prices have surged this month, with crude fetching over $99 a barrel in Friday New York trading, versus $85.76 at the end of August.

The numbers

Prices excluding food and energy-the so-called core that economists watch to help gauge underlying price trends-were up 2.4% from a year earlier. That was in line with expectations.

Over the month, however, core prices rose 0.3%, higher than the previous month and higher than expectations. The reading broke two months of mildly encouraging data that had tentatively validated central bank forecasts that inflation would slow in the second half of the year as tariff effects faded.

What exactly the Fed is watching

The data are swinging traders' bets in favor of a rate increase next week because of the report's implications for the inflation gauge that the Fed tracks-the personal consumption expenditures price index.

Poring over the CPI numbers, many economists now think that the core version of the PCE price index rose by 0.3% last month, a pace many Fed watchers have speculated could trigger a rate increase.

The official PCE metric won't be published until the end of September. But it is calculated based largely on the inflation data published this week, which allows economists and Fed officials to proceed based on well-founded estimates.

A 0.3% August core PCE increase would yield a 12-month core PCE inflation rate of about 3.4%, indicating underlying price trends well above the 2% inflation rate that the Fed targets. Inflation has run above the target since mid-2021.

How the market is reacting

Stocks rose in afternoon trading. The move might seem counterintuitive, since expectations of higher interest rates aren't necessarily good for stock prices.

Analysts said that stock investors might be betting that they now have some clarity for next week's meeting.

Stubborn price increases

Frustration with high prices has been souring feelings on the economy. The University of Michigan on Friday reported that, in a preliminary reading, its index of consumer sentiment slipped to 47.8 this month.

If the preliminary reading holds, it would be the second-lowest level in the index's decadeslong history.

Michigan said that in its surveys, consumers' mentions of both gasoline prices and tariffs have picked up.

Overall inflation stood at 2.4% at the start of the year and was widely expected to cool, which would have allowed the Fed to reduce rates. The Iran war, and the sharp increase in energy prices it brought on, changed that.

Where do prices go from here?

Economists are often in the habit of "looking through" inflation increases that come as a result of temporary shocks, such as rising gasoline prices. That is because if prices merely stabilize, the impact on overall inflation will fade.

But high fuel prices can spill over into prices for other items as well. Diesel averaged a record $6.06 a gallon on Friday, up from $3.71 a year earlier. That is adding to the cost of transporting goods, and at least some of that cost increase likely will get passed on to consumers. Meanwhile, the U.S. trade conflict with Canada risks making the impact of tariffs on inflation more protracted, and the AI build-out is, if anything, accelerating.

Self-fulfilling inflation

The biggest worry is that current, elevated inflation levels could work their way into people's inflation expectations-which can in turn affect future inflation. If workers believe inflation will remain high, for example, they can push for wage increases beyond the price increases they have already seen. Similarly, businesses will raise prices in an effort to offset the higher costs they expect to pay.

During the sharp rise in inflation that occurred after the pandemic hit, inflation expectations remained low. In recent research, economists Ulrike Malmendier and Stefan Nagel argue that came about because the years of low inflation that preceded the pandemic conditioned people to think the inflation run-up wouldn't last.

They caution, however, that a second bout of high inflation could have a more pronounced effect.

In the Michigan survey, median expected inflation over the next year jumped to 4.6% this month from 4% in August.

But inflation expectations over the next five years-a longer-term outlook that economists pay closer attention to-rose only slightly, to 3.4% from 3.3%. That is higher than it was during the two decades that preceded the pandemic, but around what it averaged in the 1990s.

The problem for Fed policymakers is that they are facing a situation where the longer inflation stays elevated, the more of a problem they might face.

Write to Justin Lahart at Justin.Lahart@wsj.com

(END) Dow Jones Newswires

September 11, 2026 14:19 ET (18:19 GMT)