By Lucia Mutikani
WASHINGTON, Sept 11 (Reuters) - U.S. consumer prices accelerated in August, while a key measure of underlying inflation posted its largest increase in four months, reinforcing expectations that the Federal Reserve will raise interest rates next week.
The Labor Department's Consumer Price Index report on Friday followed strong readings in several components of the Producer Price Index released on Thursday that feed into the Personal Consumption Expenditures price indexes, the inflation
measures the U.S. central bank tracks for its 2% target. The two reports led economists to think that PCE inflation excluding the volatile food and energy categories picked up in August.
Financial markets initially priced in a 91% chance of a quarter-point rate hike at the Fed's meeting on Tuesday and Wednesday, before settling back to 87%, CME's FedWatch tool showed. That was up from 72% on Thursday. The Fed's benchmark overnight interest rate is currently in a 3.50%-3.75% range.
Most economists said the firmer inflation readings, combined with signs of the labor market regaining its footing in August, would compel Fed officials to raise borrowing costs not only next Wednesday, but possibly again in October or December.
They argued that with the Iran war continuing, the energy shock would spread through the economy. They also expected an AI buildout to drive inflation. Crude oil prices climbed back above $100 a barrel this week, while the U.S. national average diesel price surpassed $6 a gallon for the first time.
"Energy inflation does not stay at the gas station. It travels by truck, airplane and cargo ship into nearly every store in America," said Sung Won Sohn, a finance and economics professor at Loyola Marymount University. "The Fed is now more likely than not to raise its policy rate ... it cannot afford to let an energy shock become an everything shock."
The CPI increased 0.4% last month after edging up 0.1% in July, the Labor Department's Bureau of Labor Statistics said. In the 12 months through August, consumer inflation advanced 3.4% after rising by the same margin in July. The rise in the CPI was in line with economists' expectations.
A 3.9% jump in gasoline prices after two straight monthly declines accounted for more than a third of the increase in the CPI over the month. Other motor fuels, which include diesel, surged 9.6%. They surged 44% year-on-year in August.
There was, however, some respite for consumers at the supermarket. Food prices edged up 0.1% for a second straight month. Grocery prices were unchanged amid muted increases in the costs of meat and fish. Fruit and vegetable prices fell 0.4% over the month, weighed down by a 6.2% drop in the cost of lettuce because of a Cyclospora outbreak.
But egg prices increased 2.9%, while nonalcoholic beverages cost more, as did dairy and related products. Food prices advanced 2.7% year-on-year in August and the annual increase in consumer inflation is outpacing wage growth. Inflation-adjusted average hourly earnings fell 0.3% over the year in August.
"Inflation-adjusted wage growth contracted for a fifth consecutive month in August," said Gregory Daco, chief economist at EY-Parthenon. "This is the longest income squeeze since 2012 – excluding the post-pandemic period when public assistance kept income growing despite historical job losses."
FRUSTRATION OVER RISING COST OF LIVING
Frustration over the higher cost of living has led to a sharp erosion in President Donald Trump's approval ratings and could cost his Republican Party control of the U.S. Congress in the November midterm elections, according to analysts.
The growing disenchantment was also evident in the University of Michigan's Surveys of Consumers, which showed its Consumer Sentiment Index tumbled to 47.8 in early September from 51.7 in August. The deterioration in sentiment was among both Democrats and Republicans. Consumers also anticipated higher inflation over the next 12 months and five years.
Wall Street stocks rose as oil prices retreated, though crude remained on course for a weekly gain of more than 8%. The dollar was steady against a basket of currencies. U.S. Treasury yields initially rose, with the benchmark U.S. 10-year note yield rising to 4.9915% before easing back to 4.92%.
Excluding food and energy, the CPI rose 0.3% last month, the largest increase since April. That was above economists' expectations for a second straight month of a 0.2% gain. Core CPI increased 2.4% year-on-year in August after rising 2.5% in July. Core CPI inflation was lifted by a 5.9% jump in mobile phone costs, likely related to service changes at AT&T.
Airline fares increased 2.7%, reflecting higher jet fuel costs. The cost of education and communication services rose solidly, while rents rose 0.2% and prices for hotel and motel rooms rebounded 2.4%. But healthcare costs eased and motor vehicle insurance fell 0.8%.
Core goods inflation was benign, suggesting the pass-through from import tariffs was fading, though an escalation in trade tensions between the United States and Canada posed an upside risk. There were rises in the prices of new motor vehicles as well as used cars and trucks. Prices for prescription medication were unchanged.
With the CPI and PPI data in hand, most economists expected core PCE inflation to increase 0.3% after gaining 0.2% in July. Estimates for the year-on-year increase in core PCE inflation converged around 3.4%. Core PCE inflation advanced 3.3% in the 12 months through July. The August PCE inflation report will include changes to the methodology.
Fed Chairman Kevin Warsh said last month the central bank will "have work to do" if policymakers don't get the confidence they need that inflation is heading down to 2%. But Trump is pressuring the Fed to cut rates, posting on social media last week, "LOWER THE RATE OR I'LL STOP TRADING WITH COUNTRIES WITH WHICH WE HAVE A DEFICIT."
Economists have blamed what they called political intimidation for the surge in yields on long-term U.S. government bonds.
"The markets are doing the Fed's job for it by pricing the yield curve significantly higher, and the (Federal Open Market Committee) is now behind the curve," said Brian Bethune, an economics professor at Boston College. "At this point, Warsh and the FOMC have painted themselves into a corner."
(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama, Rod Nickel and Andrea Ricci)
