July CPI: What does the Fed do now?

A fresh reading on inflation showed prices for a smattering of goods and services moved higher for Americans in July, creating a dilemma for the Federal Reserve on whether to hold interest rates steady in September.

The Consumer Price Index (CPI) for July showed prices, excluding volatile food and energy prices, rose 3.1% year over year. That was hotter than the 3% economists expected and up from 2.9% in June, when inflation was pushed higher by rising goods prices. Month-over-month CPI clocked in as expected, rising 0.3%.

On a headline basis, however, CPI rose less than expected — by 2.7%, a tenth lower than expectations for a rise of 2.8%.

Markets, meanwhile, are pricing in a 92% chance the Fed cuts rates by 25 basis points in September.

“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,” Capital Economics deputy chief North America economist Stephen Brown said.

But Brown noted that, given that several Fed members are now more worried about the job market outlook, this inflation report probably won’t be enough to prevent the Fed from cutting rates sooner than he previously expected.

“But it does support our view that markets are overestimating the degree of loosening to come over the next 18 months,” he said.

Read more: How jobs, inflation, and the Fed are all related

The Fed has been largely in a “wait and see” mode, as many central bankers want to assess the impact of tariffs on inflation.

Fed Chair Powell has said he wants to see the impact of tariffs on inflation over the months of June, July, and August, though he’s coming around to the idea that their impact may be no more than a one-time increase in prices. But as the Fed waits to see whether or not tariffs will lead to persistent inflation, July’s inflation data didn’t offer any decisive findings, with some areas of goods inflation like furniture and shoes perking up, but services inflation, which historically has been the stickier culprit, popping back up.

Inflation now stands more than a full percentage point above the Fed’s 2% target.

“This month’s report did nothing to convince anyone,” Northlight Asset Management chief investment officer Chris Zaccarelli said.

In the wake of the inflation numbers, President Trump again called on Fed Chair Jerome Powell to lower interest rates now, saying on social media that consumers aren’t paying tariffs and that it’s mostly companies and foreign governments.

“Jerome “Too Late” Powell must NOW lower the rate,” Trump posted on Truth Social. “The damage he has done by always being Too Late is incalculable. Fortunately, the economy is sooo good that we’ve blown through Powell and the complacent Board.”

In the wake of disagreement on interest rate levels, the president also said he is 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.”

Joe Lavorgna, council to Treasury Secretary Scott Bessent, notes that core goods prices are up just 0.8% since the tariffs were implemented in February and that headline inflation measured by CPI has been soft over the past three months.

“There’s been no inflation at all where people thought it would show up, and I think that’s very encouraging, and you overlay that with what’s happening on shelter and those that think you have to look at the core rate that’s going to move down quite sharply,” Lavorgna said in an interview with Yahoo Finance.

Read more: How the Fed rate decision affects your bank accounts, loans, credit cards, and investments

The inflation data come after a government report showed the US economy added just 73,000 jobs in July, while the unemployment rate moved up to 4.2% from 4.1% the month prior. At the same time, the two prior months saw downward revisions. May’s job gains were revised down to 19,000 from 144,000, while June’s additions were cut to just 14,000 from the 147,000 initially reported. That pulled the three-month average employment gain down to 35,000 — a figure many analysts are interpreting as a sign that hiring is stalling, even as population growth slows.

Lavorgna also thinks that job growth will rebound later this year as firms have gotten more certainty on tax policy.

“I would expect now, as companies are going to watch-and-see mode, that you’re going to start to see hiring pick up quite significantly,” he said. “It’s just a matter of time before you’re going to see really big improvements in demand for labor, especially now that the tax policy is clarified. Companies made a commitment to capital, now they’re going to make the commitment to labor.”

Still, the data is likely to lead to continued division within the central bank over whether to cut rates in September at this juncture.

Kansas City Fed president Jeff Schmid said Tuesday that inflation remains too high and that he favors a “patient approach” to cutting rates.

“While increased tariffs seem to be having a limited effect on inflation, I view this as a rationale for keeping policy on hold rather than an opportunity to ease the stance of policy,” Schmid said in a speech in Oklahoma City.

Overall, Schmid said he anticipates a relatively muted impact from tariffs on inflation but views that as a sign that interest rates are “appropriately calibrated” rather than a signal the Fed should cut rates. While he said job growth was weak over the summer, he stressed a broader set of indicators suggests the labor market is in balance.

He warned that the current environment is one where aggressively boosting demand could raise the risk of an outsized increase in prices as firms gain pricing power and increase the pass-through of tariffs to consumers. Schmid believes that the strength of demand will determine how much of the increase in tariffs will eventually show up in inflation.

“With the economy still showing momentum, growing business optimism, and inflation still stuck above our objective, retaining a modestly restrictive monetary policy stance remains appropriate for the time being,” he said.

Though Schmid added a caveat: He will reassess as he receives new data on inflation, the labor market, and the economy more generally.

Richmond Fed president Tom Barkin, taking a middle-of-the-road stance, said Tuesday the “fog is lifting” now that tariff deals are being nailed down, the tax bill has passed, deregulation is underway, and net immigration is down.

“We may well see pressure on inflation, and we may also see pressure on unemployment, but the balance between the two is still unclear,” Barkin said in a speech in Chicago.

Barkin says the level of consumer spending has stayed solid, but for the economy to falter, consumer spending would need to pull back more fundamentally. He said while job gains have slowed recently and are worth watching, he’s hopeful that even as businesses face increased costs from tariffs, they’ll largely avoid the type of large layoffs that would spike unemployment and lead to consumer pullback.

Other members of the Fed, like Atlanta Fed president Raphael Bostic and Cleveland Fed president Beth Hammack, are also more concerned about inflation. While both have shown concern with the latest jobs report, they are still focused on inflation, with Bostic retaining his estimate right now for only one rate cut this year.

On the other side, in recent days, more Fed officials, including San Francisco Fed president Mary Daly and Minneapolis Fed president Neel Kashkari, have made comments that set the table for cutting rates as soon as next month, citing concerns over a weakening job market.

“The labor market has softened. And I would see additional slowing as unwelcome, especially since we know that once the labor market stumbles, it tends to fall quickly and hard,” Daly said in a speech in Alaska last week. “All this means that we will likely need to adjust policy in the coming months.”

Federal Reserve governor Michelle Bowman said Saturday that she is looking at three interest rate cuts this year, citing concerns she sees that further delays in cutting rates could “result in a deterioration in labor market conditions and a further slowing in economic growth.”

This story has been updated.

Jennifer Schonberger is a veteran financial journalist covering markets, the economy, and investing. At Yahoo Finance she covers the Federal Reserve, Congress, the White House, the Treasury, the SEC, the economy, cryptocurrencies, and the intersection of Washington policy with finance. Follow her on X @Jenniferisms and on Instagram.

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