New inflation data showing a modest easing of price pressures in July has given the Federal Reserve some breathing room as it considers raising interest rates at its policy meeting next month. But the prospect of higher borrowing costs remains firmly on the table as officials begin to lose patience about how long inflation has overshot the central bank’s target.
The latest Consumer Price Index report, published by the Bureau of Labor Statistics on Wednesday, gave policymakers at the Fed some comfort about retaining that patience, at least for the time being.
The Fed’s preferred inflation gauge is the Personal Consumption Expenditures price index, of which the C.P.I. data is a crucial input. Officials pay closest attention to the so-called core measure, which strips out volatile food and energy prices and is thought to be a better measure of underlying inflation. In July, those prices rose 0.2 percent from the previous month, or 2.5 percent compared with the same time last year.
Officials have suggested that this kind of monthly pace is consistent with inflation’s eventually retreating to the Fed’s target — something that has been missed for five years. The central bank’s goal is 2 percent, as measured by the P.C.E. index. As of the latest data in June, it was running at 3.7 percent.
The Fed next votes on rates in mid-September, and a string of benign inflation reports from here on out would help to alleviate pressure on the central bank to take action. The next P.C.E. report will be released on Aug. 26.
Before Wednesday’s data, a growing cohort of policymakers believed the central bank should have already raised rates to speed up the pace at which inflation falls back to a more palatable level. They did not buy the argument backed by other officials, which centered on the idea that price pressures would ease on their own as temporary factors caused by tariffs and the war with Iran fade.
The latest inflation report did not definitively resolve the disagreement. According to Riccardo Trezzi, a former Fed economist who runs the research firm Underlying Inflation, July’s P.C.E. data is at risk of showing slightly hotter consumer price growth than the C.P.I. report. The Fed will also get another round of inflation data before it meets in September. On top of this, it is still unclear whether rates at the current level of 3.5 percent and 3.75 percent are putting any downward pressure on inflation, Mr. Trezzi said.
“I think the debate between hike or no hike will go on for a month and a half,” he said. “It’s complicated to hold; it’s also complicated to hike, and it’s almost impossible to cut.”
What has snarled the Fed’s internal debate is the labor market, which last month showed some signs of having lost momentum even as the unemployment rate ticked down.
Veronica Clark, an economist at Citigroup, described the labor market as “not very healthy,” pointing to the fact that people are leaving the labor force and wage growth has been “really weak.” She predicts inflation will continue to decelerate in the latter half of the year, driven primarily by a slowdown in housing-related costs.
The Fed’s next steps are under heightened scrutiny after the most recent policy gathering at the end of last month. Officials held rates steady as expected, but Kevin M. Warsh, the new chairman, sent mixed signals about how he expected to make good on his pledge to get inflation down.
He did not articulate a clear reason the Fed opted to hold rates steady in July, nor did he say unequivocally that higher rates were the primary tool to get inflation down. His decision to repeatedly highlight how financial conditions had tightened in the absence of rate increases gave the impression that he was comfortable letting markets do part of the central bank’s policy tightening work for it. Moreover, his passing suggestion that the Fed might consider changing the 2 percent inflation target at some point stoked further confusion.
After the communications mishap, which rattled the U.S. government bond market, the onus is now on Mr. Warsh to reset the narrative. His next scheduled opportunity will be at the central bank’s annual conference in Jackson, Wyo., at the end of the month.
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