U.S. inflation came in slightly softer than expected in July, reinforcing market bets that the Federal Reserve could begin cutting interest rates as soon as September, even as the central bank remains divided over the urgency of easing monetary policy.
The Bureau of Labor Statistics (BLS) reported Tuesday that the consumer price index (CPI) rose 0.2% on the month and 2.7% over the past year, compared with Dow Jones estimates of 0.2% and 2.8%. Core CPI, which strips out food and energy prices, climbed 0.3% for the month — the highest monthly gain since January — and 3.1% from a year ago, its strongest since February.
Shelter costs rose 0.2% and were the largest contributor to the monthly increase, while food prices were unchanged and energy costs fell 1.1%. Tariff-sensitive new vehicle prices were flat, though used cars and trucks rose 0.5%. Transportation and medical care services both increased 0.8%. Household furnishings and supplies, which often reflect tariff effects, gained 0.7% after a 1% jump in June, while apparel prices were up just 0.1%.
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The figures left inflation more than a full percentage point above the Fed’s 2% target, keeping pressure on policymakers. But markets saw the softer-than-expected annual reading as a sign that the Fed could prioritize a weakening labor market over stubborn price growth in its September decision.
“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 at Capital Economics.
He noted that with several Fed members now more worried about the job market, this report “probably won’t be enough to prevent the Fed from cutting rates sooner” than he initially expected. However, he cautioned that markets may be overestimating how much the Fed will loosen policy over the next 18 months.
Fed Chair Jerome Powell has previously said he wants to assess tariff impacts over June, July, and August before deciding on rates, but recent data has bolstered the view that tariffs are likely causing only a one-time bump in prices rather than a persistent inflationary trend. Still, services inflation — often considered stickier than goods — ticked higher in July, keeping the policy outlook uncertain.
Political pressure on the Fed is also intensifying. President Donald Trump once again called for immediate rate cuts, posting on Truth Social that “Jerome ‘Too Late’ Powell must NOW lower the rate,” insisting that consumers aren’t bearing the cost of tariffs and criticizing Powell for acting too slowly. Trump also said he is considering allowing a lawsuit against Powell to proceed, citing dissatisfaction with his performance and even pointing to grievances over the construction of Federal Reserve buildings.
The inflation report came just days after government data showed the U.S. economy added only 73,000 jobs in July, with the unemployment rate ticking up to 4.2% from 4.1%. Previous months’ employment numbers were also revised sharply lower, pulling the three-month average job gain down to just 35,000 — a level many analysts view as a sign of stalling hiring.
Joe Lavorgna, council to Treasury Secretary Scott Bessent, said core goods prices have risen just 0.8% since Trump’s tariffs took effect in February, and that headline CPI has been soft over the past three months. He argued that shelter costs are likely to ease and predicted a sharp drop in core inflation. Lavorgna also expressed optimism that hiring will rebound later this year as businesses gain clarity on tax policy and shift from capital investment to labor expansion.
Within the Fed, divisions over a September rate cut remain stark. Kansas City Fed president Jeff Schmid said Tuesday that inflation is still too high and that he favors a “patient approach” rather than immediate easing, warning that aggressive rate cuts could give firms more room to raise prices and pass along tariff costs.
Richmond Fed president Tom Barkin took a more balanced stance, saying the “fog is lifting” on economic policy but that the balance between inflation and unemployment pressures remains unclear.
Meanwhile, some policymakers have openly signaled readiness to cut. San Francisco Fed president Mary Daly said the labor market has “softened” and that further slowing would be “unwelcome,” while Fed governor Michelle Bowman said she is considering three cuts this year, warning that delaying action could worsen the labor market and slow growth further. Minneapolis Fed president Neel Kashkari has also backed an earlier cut, citing labor market fragility.
Markets are already positioned for action, with futures pricing in a strong likelihood of a September rate cut and raising the probability of another in October to about 67%, up from 55% before the CPI release, according to CME Group’s FedWatch tool. Still, with inflation stubbornly above target, the jobs market slowing, and policymakers split, the coming weeks of data — including August inflation numbers and the next jobs report — will be pivotal in determining whether the Fed moves next month or waits for further confirmation.