Key Takeaways
A key inflation report due Friday has gained new significance after a string of economic data shifted the outlook for a Fed rate cut.
Several reports showed the economy is stronger than experts thought amid tariff pressures, potentially reducing the urgency for the Fed to cut rates.A hotter-than-expected inflation report could encourage Fed officials to keep the key fed funds rate high to fight inflation, which is running above the Fed’s goal of a 2% annual rate.
Friday’s key report on inflation is even more significant after recent data showed the economy has been more resilient than expected in the face of tariffs.
Forecasters expect a report from the Bureau of Economic Analysis to show that prices as measured by Personal Consumption Expenditures rose at a rate of 2.7% in August, up from a 2.6% annual rate in July, according to a survey of economists by Dow Jones Newswires and The Wall Street Journal. “Core” PCE—which excludes the volatile food and energy sectors and is the Federal Reserve’s preferred measure of inflation, is expected to have risen 2.9% over the year, the same rate as July.
No Guarantee Of A Rate Cut
The Fed is widely expected to cut interest rates at its next meeting in October. But it could leave them unchanged if inflation comes in higher than expected, especially in the wake of several other stronger-than-expected economic reports this week.
A report Thursday showed that GDP rose more than originally estimated in the second quarter, while a separate report found that jobless claims fell last week. Data out Wednesday showed that sales of new homes jumped a very healthy 20% in August. All of this indicates that the economy remains resilient in the face of tariffs, potentially reducing concerns that the job market is deteriorating.
That’s significant because Fed officials have been torn between their dual goals of supporting the job market (which calls for lower interest rates) and keeping a lid on inflation (which requires higher rates for longer.)
Why the Inflation Report Matters
Friday’s inflation reading could move markets, especially if it comes in higher than forecast. A report showing that inflationary pressures are increasing could cause the Fed to keep interest rates higher for longer, which affects borrowing costs on credit cards, car loans, and other short-term debt. Higher rates also keep yields high on CDs and high-yield savings accounts.
A Slow Job Market Competes With High Prices
Lately, Fed officials have said they’re more concerned about the job market than inflation, and cut rates by a quarter point for the first time this year last week. But a hotter-than-expected inflation report could derail plans for further cuts.
Economists largely expect inflation to rise steadily this year as tariffs push up prices for imports, while inflation decelerates for other key prices including rent.
“We expect the underlying inflation trend to keep falling but the cumulative tariff effect to grow, pushing the year-on-year rate a bit higher to a peak of 3.2% in December before it resumes its decline in 2026,” David Mericle, chief U.S. economist at Goldman Sachs, wrote in a commentary.
For now, Core PCE inflation is still above the Fed’s goal of a 2% annual rate.
“With inflation still above target, [Thursday’s] release likely argues against significant cuts to the policy rate in the coming months,” Richard Flax, Chief Investment Officer at Moneyfarm, wrote in a commentary.
That point of view was echoed by at least one Fed policymaker Thursday.
“My view is that inflation remains too high while the labor market, though cooling, still remains largely in balance,” Jeffrey Schmid, president of the Kansas City Fed, said at an event in Dallas according to prepared remarks. “I view the current stance of policy as only slightly restrictive, which I think is the right place to be.”
As of late Thursday afternoon, financial markets were pricing in an 85.5% chance of a Fed rate cut in October, down from a 92% chance on Wednesday, according to the CME Group’s FedWatch tool, which forecasts rate movements based on fed funds futures trading data.
Financial markets could slip Friday if inflation comes in higher than expected. The prospect of lower interest rates, and lower borrowing costs, generally sends stock prices higher.
“Markets want more concrete evidence that inflation is cooling,” Daniela Sabin Hathorn, senior market analyst at Capital.com, wrote in a commentary. If inflation is higher than expected, she added, stocks could take a hit.