Fed rate hike in September is all but guaranteed after CPI report, economists say

A hotter-than-expected inflation report has sharply raised the likelihood that the Federal Reserve will increase interest rates in September, which would mark its first rate hike since 2023.

The Consumer Price Index rose at an annual rate of 3.4% in August, in line with July’s reading but higher than the 3.3% economists were forecasting. One-third of the monthly increase was due to gasoline prices, which have jumped 27.4% from a year ago, according to the Labor Department.

More concerning for the Fed, core prices rose 0.3% from July, higher than expected and an acceleration from the previous month’s 0.2% increase. The reading, which excludes the volatile gas and food categories, suggests inflationary pressures are broadening beyond energy as higher fuel prices ripple through the economy.

After the CPI report was released, the likelihood of a rate hike at the Fed’s Sept. 16 meeting jumped to nearly 90%, up from 70% on Thursday, according to CME FedWatch. The inflation reading makes it more likely the Fed will raise borrowing costs as it works to bring inflation back toward its 2% target, economists said Friday.

EY-Parthenon now projects the central bank will raise rates by 25 basis points at next week’s meeting, bringing the federal funds rate to a target range of 3.75% to 4%.

“We are changing our Fed call from a hold to a 25bps hike at the FOMC meeting next week,” EY-Parthenon chief economist Greg Daco wrote in a Friday note. Some Fed officials are likely to “argue in favor of a rate hike on the basis that the ‘speed’ of the disinflationary process is not satisfactory.”

The Fed is scheduled to announce its interest rate decision at 2 p.m. ET on Wednesday, Sept. 16.

More rate hikes in store?

The last time the Fed hiked rates was in July 2023 in an effort to quell prices after the pandemic pushed inflation to its highest level in decades.

A September hike may not be the last, with Capital Economics projecting a second 0.25 percentage point increase in December followed by another in March 2027.

An interest rate hike would raise borrowing costs for consumers, making mortgages, credit cards and auto loans more expensive. On the flip side, it would provide a boost to savers through higher returns on their CDs and high-yield savings accounts.

The August inflation data was captured before the recent run-up in fuel prices, with oil surpassing $100 a barrel and diesel pushing above $6 a gallon this week. 

“The renewed march higher in oil, gasoline and diesel prices adds to concerns that higher energy prices could spill over to other goods and services and inflation expectations,” Nationwide chief economist Kathy Bostjancic said in an email Friday. “As such, we are now looking for the Fed to raise rates by 25 basis points at next week’s policy meeting.”

A divided Fed

A handful of members of the 12-person Federal Open Market Committee, which sets rates, have already signaled they are willing to hike if price pressures don’t show signs of improvement.

At its last meeting in July, the Fed held rates steady, although three members dissented and voted to raise rates. Some Fed officials, including Fed governor Christopher Waller, have also indicated that they would support a rate hike in September if inflation does not make meaningful progress toward the Fed’s 2% target.

The Fed’s decision comes as it navigates ongoing price pressures from the Iran war, which has led to a global oil shortage and caused a spike in energy costs.

Inflation is now a full percentage point higher than it was before the conflict in the Middle East started at the end of February.

Brent crude, the international standard, was trading at around $105 a barrel on Friday, while the national average for diesel, widely used across the transportation, construction and agriculture industries, broke above $6 a gallon this week.

The Russia-Ukraine war is also weighing on oil prices. A barrage of Ukrainian drone strikes on Russian energy infrastructure has hampered Russia’s refining capabilities, sparking a fuel shortfall.