Fed given room to breathe as US inflation eases slightly to 3.4%

Inflation in the U.S. slowed in July and a measure of underlying price pressures also cooled, according to official data Wednesday that suggested higher oil and gas prices from the Iran war were only having a limited impact on broader costs in the economy.

Consumer prices rose 3.4% last month from a year ago, down slightly from 3.5% in June, the Labor Department said Wednesday. But inflation is still higher than before the Iran war began in February, when it was 2.4%. On a monthly basis, prices rose just 0.1% from June to July.

The modest decline could ease pressure on the inflation-fighters at the Federal Reserve (Fed) and may give them some room to maneuver ahead of potential rate hikes.

Yet prices are still rising more quickly than average wages, underscoring the struggle many Americans have had with more expensive groceries, gas, and health care, trends that have taken on a high profile in the fast-approaching midterm elections.

U.S. households have been battered by more than five years of elevated prices since the pandemic hit, and the July data is still well above the Fed’s long-term 2% target.

President Donald Trump’s Republicans are facing a stern test in upcoming midterm elections, with Democrats seeking to wrest control of Congress over his handling of the world’s largest economy.

Inflation has surged since Trump launched the war on Iran, with Tehran’s retaliatory action virtually blocking the critical Strait of Hormuz through which a fifth of global energy supplies normally transit.

Consumer inflation came in at 2.4% in February, before spiking to a three-year high of 4.2% in May.

In July, energy prices continued to lead the line in terms of price increases, with gasoline prices – a sensitive political issue – up 24.6% from a year ago.

Fuel oil, used by households for heating and in various industrial applications, was up 39.1% from the year before.

Still, the energy index overall was 1.5% lower than a month ago, indicating a downward trajectory for prices of those commodities as talks to end the war continue.

Excluding the volatile food and energy categories, core inflation also slipped to 2.5% in July from a year ago, down from 2.6% in June.

Core prices rose 0.2% from June to July. Monthly increases at about 0.2% would be low enough over time to bring inflation closer to the Fed’s 2% goal.

Still, oil prices remain elevated and gas prices rose in late July and August, suggesting overall inflation could accelerate next month. On Wednesday, gas averaged $4.04 a gallon nationwide, 16 cents higher than a month ago, according to the motor club AAA.

Key questions for Fed policymakers

Inflation has been pushed higher by a series of shocks to the economy, including Trump’s tariffs imposed last spring, higher gas prices stemming from the Iran war, and a surge in investment in artificial intelligence infrastructure that has boosted computer chip prices.

The key question for the policymakers at the Fed – not to mention for consumers struggling with high gas and grocery prices – is how quickly those one-time effects will fade or whether they will lead to persistently rising prices.

Wednesday’s figures could bolster officials at the Fed who believe the central bank can leave its key rate on hold at about 3.6% while inflation steadily declines on its own as those temporary factors fade.

Overall, price increases have stayed above the Fed’s 2% target for more than five years, suggesting that more than temporary factors may be at work. The cost of services such as health care, restaurant meals, and car maintenance are on average rising at more than 3% annually, and they aren’t particularly sensitive to gas prices or AI investment.

Rising costs for services often reflect higher wages, as companies charge more to offset the cost of higher pay. But incomes aren’t growing fast enough to sustain inflation, economists note.

It’s a confounding situation that has left many economists – and Fed officials – seeking more information to determine where inflation is headed.

“You’ve got all these things that are just not the way the economy used to behave,” Diane Swonk, chief economist at KPMG, said.

For many consumers, years of sharply rising grocery prices have led them to adopt a wide range of coping strategies, from comparison shopping to couponing, to cutting back on favorite foods.

Many firms still pass on higher costs

Some retailers, such as Walmart, have responded by rolling back food prices, a trend that could have lowered July’s inflation figures. Yet many other firms are still passing on higher costs.

Paint company Sherwin-Williams is planning an 8% price increase effective Sept. 1 to offset higher raw material costs, CEO Heidi Petz told analysts late last month. She said that because of the company’s strong relationships with suppliers, it was able to delay price increases until now.

“We are seeing the impact of higher oil and related cost pressures, and we expect continued volatility throughout the balance of the year,” she said.

Wednesday’s report comes as the Federal Reserve is sharply divided over whether it should hike its key interest rate to combat inflation. The Fed kept its rate unchanged, at about 3.6%, at a meeting late last month. But the vote was 9-3, with three dissenters favoring a rate hike.

And at a July 29 news conference explaining the decision, chair Kevin Warsh was vague about the Fed’s next steps, in keeping with his focus on reining in the central bank’s previous willingness to signal whether it was prepared to raise or cut borrowing costs.

“If inflation continues to be elevated… interest rates could well be part of that solution,” he said. “But I wouldn’t say it’s in isolation.”

Long-term interest rates rose after Warsh’s comments, suggesting investors worried that inflation could worsen in the coming months and the Fed might not lift borrowing costs to fight rising prices.

Complicating matters, the government said last week that employers had cut jobs in July, a sign of potential economic weakness. The Fed typically avoids rate hikes when hiring is faltering, because higher borrowing costs could slow the economy further.

DAILYSABAH