A key US inflation measure increased in July as the costs of President Donald Trump's tariffs continue to be felt in the economy, further underscoring the Federal Reserve's dilemma at a time of pressure from the White House to cut interest rates.
A report from the Bureau of Labour Statistics showed that the consumer price index rose 2.7 per cent last month on an annual basis, less than expected. However, core inflation, which does not include food and energy, rose 3.1 per cent year on year, higher than the 2.9 per cent reading in June and at its fastest annual rate since February.
Prices for imported items such as household furnishings, apparel and recreational goods all rose last month, while medical care services and airfare prices were also above recent trends.
“We've definitely seen some heating up driven by tariffs, but it's a very messy picture,” said Michael Pearce, deputy chief US economist at Oxford Economics.
Wall Street, however, reacted positively to Tuesday's report which probably was not hot enough to prevent the Fed from resuming rates cuts in September. The S&P 500 and Nasdaq Composite hit intraday highs, while the Dow Jones Industrial Average rose more than 1 per cent.
Traders still widely expect the Fed will reduce the federal funds rate – which it has held steady this year – by 25 basis points when it meets next month.
Driving expectations of that cut have been concerns about the health of the US labour market. Government data this month showed that the unemployment rate rose to 4.2 per cent in July while the economy added only 73,000 jobs. Sharp downward revisions were also made to previous monthly gains.
“Suddenly, you've got this picture of a labour market which looks like it has suddenly lost a lot of momentum,” Mr Pearce said.
Signs of a weakening labour market also come as inflation is not just above the Fed's long-term target, but is trending in the wrong direction.
Unlike other central banks, the Federal Reserve has a dual mandate of price stability and maximum employment. A large majority of Fed officials this year have taken a wait-and-see approach towards cutting rates this year as they assess the effects of Mr Trump's tariffs on the economy.
Federal Reserve chairman Jerome Powell has warned that the Fed could find itself in a position in which those two goals are in conflict because of the effects of those tariffs.
Addressing reporters after holding rates last month, Mr Powell outlined his reason for keeping them elevated, adding that the economy is still in the “early days” of feeling the tariffs' effects.
“When we have risks to both goals, and one of them is farther away from goal than the other, and that's inflation, that means policy should be tight, because tight policy is what brings inflation down,” he said.
But the July jobs report is testing that resolve. A handful of Fed officials – including governors Michelle Bowman and Christopher Waller, two Trump appointments who dissented from last month's decision – have suggested since that rate cuts should come sooner to protect the labour market.
Derek Tang, an economist at LHMeyer/Monetary Policy Analytics in Washington, said the jobs report was a wake-up call for people who were counting on the resilience of the US economy, which is now showing signs of stress.
“Of course, that might be affected by immigration but just the fact that demand is cooling really unsettles a lot of people,” he said.
“The second reason why I think the market is talking about September is simply the political environment, or how much longer can the Fed be immune from Trump pressure.”
Mr Trump seized on Tuesday's inflation report to continue his pressure campaign against Mr Powell to cut rates and again attacked overrun renovation costs at the Fed's headquarters. Mr Trump claims the costs of the project have swollen to $3 billion, which Mr Powell has said is untrue.
“I am … considering allowing a major lawsuit against Powell to proceed because of the horrible, and grossly incompetent, job he has done in managing the construction of the Fed Buildings,” Mr Trump wrote on the Truth Social media platform.
Adding further pressure on Mr Powell will probably be the confirmation of Stephen Miran, a Trump ally and Fed critic, to temporarily fill the seat vacated by former Fed governor Adriana Kugler. Her term is set to expire January 31, 2026.
By installing Mr Miran at the Federal Reserve even in a temporary capacity, it would add a third prominent voice to lower interest rates. The rate-setting Federal Open Market Committee consists of Mr Powell, six other members on the board of governors, the New York Fed president and four of the 11 regional presidents who serve on a rotating basis.
It is unclear if Mr Miran will be confirmed by the US Senate in time for the Fed's meeting next month. Mr Miran told CNBC on Tuesday that he believes inflation “has been well behaved, particularly since the President took office”. He also said the central bank's independence is of “paramount importance” but declined to elaborate further, citing his confirmation process.
The Federal Reserve has indicated it expects to cut interest rates by a cumulative 50 basis points this year, according to projections from the Fed's June meeting.
