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A hotter than expected reading on core inflation has dramatically increased the likelihood that the Federal Reserve will raise interest rates at its next policy meeting. Markets now assign a 90% probability to a rate increase, according to CME FedWatch.

The Consumer Price Index rose 0.4% in August from the previous month and 3.4% from one year earlier, both matching expectations.

However, core CPI, which excludes volatile food and energy costs, climbed 0.3% for the month, exceeding the expected 0.2% gain.

That core reading carries considerable weight because Federal Reserve officials use it to assess whether price pressures are becoming embedded throughout the economy.

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“The upside surprise to core CPI in August means the Fed looks set to hike next week,” said Stephen Brown, North America chief economist for Capital Economics.

Officials are expected to evaluate inflation trends across three, six, and 12 month periods before deciding whether monetary policy remains restrictive enough.

The latest figures suggest the recent improvement in price growth may have been temporary rather than the start of a durable retreat toward the Fed target.

The central bank remains divided over whether inflation will gradually return to its 2% objective without further intervention.

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Officials including Cleveland Fed president Beth Hammack and Dallas Fed president Lorie Logan have argued that price increases remain broad and may require additional tightening.

The August report gives that camp fresh ammunition while placing officials who favor patience in a difficult position.

Fed governor Christopher Waller had previously suggested that a 0.2% core monthly reading could support keeping rates unchanged.

“If there is continued progress toward our 2% goal, then I am willing to support holding the policy rate at its current level,” Waller said on Sept. 3. His condition for supporting a pause now appears harder to satisfy following the stronger August figure.

“But if inflation comes in hot, I would consider a rate hike.

I judge that policy is currently only slightly restricting aggregate demand, and it may not take much acceleration in inflation to nudge me into supporting tighter policy,” Waller added.

Fed Chairman Kevin Warsh has also warned that inflation remains too high and that borrowing conditions are not particularly restrictive outside the housing market.

Progress recorded during June and July had not convinced him that inflation was moving decisively lower.

“Following a brief easing in June and July, inflation surged again in August which sets the stage for a likely interest rate hike,” RSM chief economist Joseph Brusuelas said.

He expects at least two additional increases after the coming meeting during the next year to restore a credible path toward 2% inflation.

The Fed will also use consumer and wholesale inflation reports to estimate the Personal Consumption Expenditures index, its preferred inflation measure. Brown estimates that core PCE increased 0.27% in August, potentially lifting its annual rate from 3.3% in July to 3.4%.

“In short, core PCE inflation is moving in the wrong direction, and that should be enough for the centrists on the FOMC such as Governor Christopher Waller to support a hike next week,” Brown said.

Such an increase would reinforce concerns that stubborn inflation is becoming more difficult to contain.

Oil near $100 per barrel further complicates the debate by threatening another wave of higher transportation, manufacturing, and consumer costs.

The Fed traditionally looks beyond temporary energy shocks, but inflation has remained above target for five and a half years.

“The policy question is now not so much whether August CPI broadly confirms the summer improvement in the inflation data but rather whether that summer improvement provides sufficient reassurance for the Fed to look through a renewed oil supply shock with outsized impact on diesel and other refined products,” said Krishna Guha, head of central bank strategy and economics for Evercore ISI.

Some economists still believe the underlying economy does not justify another increase.

“On the month this morning's release pushes the Fed into an almost certain hike in September.

But I still don't think the economic data merit that because more broadly, there's no real sign of inflation problems stemming from strong consumer demand in CPI data,” Wilmington Trust chief economist Luke Tilley said.

“So, they've almost backed themselves into a corner,” Tilley added. With core prices accelerating and oil climbing, the Fed must now choose between tightening into uncertain demand or risking another loss of inflation credibility.

DISCLAIMER: GoldInvestors.news is not a registered investment, legal or tax advisor or broker/dealer. All investment/financial opinions expressed by GoldInvestors.news are from the personal research and experience of the owner of the site and are intended as educational material. Although best efforts are made to ensure that all information is accurate and up to date, occasionally unintended errors and misprints may occur.