Fed rate-hike bets rise to 85% after hot August inflation data

The case for a Federal Reserve rate hike next week strengthened after another reading showed US inflation remaining stubborn, raising concerns that price pressures could take longer to ease.

According to Reuters, traders are now pricing in about an 85% chance of a 25-basis-point rate increase at the Fed's September 15-16 meeting, up from roughly 70% before the latest inflation report. Markets are also beginning to price in the possibility of another hike in December.

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Core inflation stays firm

US consumer prices excluding food and energy, a key measure of underlying inflation, rose 0.3% in August from July, exceeding economists' expectation of a 0.2% increase, according to data from the Bureau of Labor Statistics cited by Reuters.

Core CPI rose 2.4% from a year earlier, while headline inflation was at 3.4%. The latest figures followed a stronger-than-expected producer price report on Thursday, adding to concerns that the recent improvement in inflation may be losing momentum.

The backdrop has become more challenging as oil prices have climbed above $100 a barrel amid renewed tensions in the Middle East. Reuters reported that the combination of firmer inflation, higher producer prices and rising energy costs could complicate the Fed's efforts to bring inflation back to its 2% target.

"Today’s clean 0.3% core CPI print, combined with the sharp rise in energy prices and persistent tensions with Iran, all but locks in a Fed rate hike next week," Principal Asset Management chief global strategist Seema Shah wrote, according to Reuters. "After half a decade of above-target inflation, policymakers are likely to conclude that more than one hike will be needed to re-establish price stability."

The Fed has kept its policy rate in the 3.50%-3.75% range throughout the year. A 9-3 vote in July showed growing support within the central bank for higher rates, Reuters reported.

Markets weigh another hike

Economists remain divided over whether the August inflation data is strong enough to warrant a rate increase.

The Fed's preferred inflation gauge is the personal consumption expenditures price index rather than CPI. Reuters reported that Oxford Economics analysts expect core PCE inflation for August to have risen a "benign" 0.2%, helped by declines in software and accessories prices and slower growth in core goods prices.

That could give policymakers room to hold rates next week, although the analysts described the decision as being on a "knife's edge".

Other economists expect a stronger core PCE reading. At least two Wall Street firms have also shifted their forecasts to a rate hike next week after previously expecting the Fed to hold rates steady, according to Reuters.

"This call reflects the inflation data, but also the market expectations as Chairman Warsh will want to avoid a dovish surprise next week," Piper Sandler analysts wrote.

Some economists, however, see the latest inflation increase as a temporary setback rather than a renewed acceleration.

"We don’t think today’s print portends a reacceleration of core inflation, but merely a bump on the disinflationary road," Natixis economist Christopher Hodge wrote. "We think a nudge via a hike or two is probably what the Fed will think is appropriate, starting with a hike next week."

With inflation still above target and energy prices adding to the pressure, investors are now focused on whether the Fed will deliver the rate increase markets are increasingly expecting.

(Disclaimer: This article is based on inputs from agencies. These do not represent the views of The Economic Times)