WASHINGTON — U.S. inflation held steady in August, but a stronger-than-expected increase in underlying prices has sharply increased expectations the Federal Reserve will raise interest rates when it meets this week.
The Labor Department reported Friday that consumer prices were up 3.4% from a year earlier, matching both July’s inflation rate and economists’ expectations.
But the details of the report offered less reassurance that inflation is moving toward the Fed’s 2% target.
Prices excluding volatile food and energy costs — the so-called core inflation measure — increased 0.3% from July, exceeding expectations and accelerating from the previous month. Core prices were up 2.4% from a year earlier.
The monthly increase interrupted two months of more encouraging inflation data that had supported Fed forecasts that price pressures would ease during the second half of 2026 as some effects of tariffs faded, the Wall Street Journal noted in its analysis.
“Both headline and core inflation accelerated monthly in August. Upside risk to the inflation outlook increased as oil prices continued to climb,” Dawit Kebede, senior economist with America’s Credit Unions, said in a statement. “A prolonged increase in energy prices could spill over into the prices of other goods and services. The report gives hawkish members of the Federal Reserve more reason to argue for a rate hike given a strong economy and low unemployment. Markets have already increased the odds of a September hike in recent weeks.”
Rate Hike Expectations Jump
Financial markets responded by substantially increasing bets that the Fed will raise its benchmark interest rate by a quarter percentage point at its policy meeting next week.
Interest-rate futures indicated about a 90% probability of a quarter-point increase following the inflation report, up from approximately 70% beforehand, according to the Journal.
“If you don’t raise rates now you better have a damn good story on why you didn’t,” Omair Sharif, head of advisory firm Inflation Insights, told the Journal.
Fed policymakers have been divided over whether another rate increase is necessary. Three officials dissented at the central bank’s July meeting in favor of raising rates, and other policymakers have since indicated they could support an increase if inflation failed to improve.
The decision has been further complicated by another surge in energy prices. Crude oil was trading above $99 a barrel Friday, compared with $85.76 at the end of August.
Fed’s Preferred Measure Also in Focus
Economists are using Friday’s consumer price data to estimate the personal consumption expenditures price index, the inflation gauge preferred by the Fed.
The Journal reported many economists now estimate core PCE prices increased 0.3% in August. That would put the 12-month core PCE inflation rate at approximately 3.4%, well above the Fed’s 2% target.
The official August PCE report will not be released until later this month.
Inflation has remained above the Fed’s target since mid-2021, frustrating expectations that price pressures would ease enough this year to allow policymakers to lower interest rates.
Overall inflation stood at 2.4% at the beginning of 2026. But the war involving Iran and resulting increase in energy prices, President Donald Trump’s tariffs and price pressures associated with the rapid expansion of artificial intelligence infrastructure have contributed to renewed inflation concerns, according to the Journal.
Gas, Diesel Prices Add Pressure
Energy costs have become a particularly significant source of pressure.
Regular gasoline averaged $4.07 a gallon in August, compared with $3.16 a year earlier, according to AAA figures cited by the Journal. The average had risen to $4.30 by Friday.
Diesel prices reached an average $6.06 a gallon Friday, compared with $3.71 a year earlier. Higher diesel costs could spread inflation beyond the energy sector by increasing the cost of transporting goods.
The AI infrastructure boom is creating another source of price pressure by contributing to shortages of memory and storage chips used in consumer electronics, the Journal reported.
Tariffs could also continue putting upward pressure on prices as businesses pass higher import costs to consumers. More recently imposed tariffs on Canadian goods could extend those effects.
Risk of Inflation Becoming Entrenched
Fed officials are also watching whether prolonged inflation begins changing consumer and business expectations.
If workers come to expect higher inflation, they may demand larger wage increases, while businesses expecting higher costs may raise prices. Those reactions can make inflation more persistent.
