US Inflation Surprises Upward Ahead of Fed Meeting, But Markets Still Price Rate Cuts

US consumer prices rose more than economists expected in August, complicating the backdrop for the Federal Reserve as it prepares for a policy decision next week but doing little to derail market expectations for rate cuts.

The consumer price index climbed 0.4 percent from July, above forecasts of 0.3 percent and following a 0.2 percent gain in July, the Labor Department reported. On a 12-month basis, headline inflation accelerated to 2.9 percent from 2.7 percent a month earlier. Excluding volatile food and energy components, core inflation was unchanged month-on-month and stood at 3.1 percent year-on-year.

Economists and market observers said the data showed signs that tariff-driven price pressures were starting to appear in the inflation numbers. "The evidence is overwhelming that more tariff-related inflation is coming, though it may still be several months before it passes through fully," said Stephen Stanley, chief economist at Santander US Capital Markets. Atakan Bakiskan, US economist at Berenberg, said: "President Donald Trump's inflationary policies – tariffs and restrictive immigration measures – are gradually showing up in the hard data and continue to erode consumers' purchasing power."

The report arrived ahead of the Federal Open Market Committee meeting scheduled for Sept. 17 and the central bank's widely anticipated move to begin easing policy. Despite the hotter-than-expected CPI print, markets remain confident the Fed will cut rates next week. Traders are pricing in three 25 basis-point cuts this year, which would lower the Fed's target range from the current 4.25–4.50 percent to 3.50–3.75 percent by the end of the year if forecasts hold.

The inflation update was released alongside weekly initial jobless claims data that showed first-time applications for unemployment benefits rose to 263,000 in the week ending Sept. 6, up from 237,000 the prior week. That was the fastest week-to-week increase since October 2024 and the highest level of claims since October 2021.

"Quite how hot a CPI we would have needed today to deter a Fed move next week is now an academic question," said Chris Beauchamp, chief market analyst at IG. "The data is clear, a weakening picture in employment means the Fed has to push on with easing even with inflation fears still lurking. Perhaps Powell will be privately glad that he has such cover, since it helps allay concerns that the Fed has buckled under White House pressure."

Suggestions that Fed Chair Jerome Powell might opt for a larger, 50 basis-point cut at the Sept. 17 meeting were tempered by the CPI figures. "An emergency sized rate reduction is not required," said Seema Shah, chief global strategist at Principal Asset Management. She noted that while jobless claims have jumped, they remain low relative to 2021 levels and broader activity and corporate earnings do not point to an imminent recession.

The data also arrived in a busy week for other major central banks. The European Central Bank held eurozone interest rates steady on Thursday, and the Bank of England's monetary policy committee is due to meet next week, with most analysts expecting the BoE to keep its bank rate at 4 percent.

Market pricing implies a 25 basis-point cut at the September Fed meeting that would take the policy range to 4.00–4.25 percent, followed by two additional 25 basis-point moves through the rest of the year. Analysts cautioned that incoming monthly data in the coming weeks, including retail sales and producer prices, could shift the outlook for both the size and timing of Fed easing.

Policymakers face a balancing act between higher short-run inflation readings and signs of a weakening labour market. The Fed has signalled it will weigh a broad set of indicators rather than any single data point as it considers whether to begin lowering rates after more than two years of tightening.