Inflation cools, casting doubt on a second 2026 rate hike

US inflation increased less than economists expected in August, offering some relief to markets and giving the Federal Reserve more time to decide its next move on interest rates.

A major upward revision to Q2 GDP also pointed to a resilient economy.

The Personal Consumption Expenditures (PCE) price index, the Fed’s preferred inflation gauge, rose 0.3% from July and 3.4% from a year earlier, well below the 3.7% Dow Jones estimate.

Core PCE, which excludes volatile food and energy prices, climbed 0.2% during the month and 3% year over year. Both readings were below forecasts.

Meanwhile, the Commerce Department revised its Q2 growth estimate to 2.2%, up from 1.5%.

But inflation isn’t beaten yet
Despite the softer numbers, inflation remains well above the Fed’s 2% target. Energy costs were a major driver in August, with gasoline prices jumping 4.4%.

The report also showed that Americans continued to spend heavily. Personal spending increased 0.9%, per the BEA, while incomes rose 0.2%.

What it means for interest rates
The softer inflation data pushed down expectations for an October rate hike, which FedWatch put at 70% Monday. But they dropped to 51.5% Tuesday after New York Fed President John Williams said there was “no urgency” to raise rates again, then fell to 41.5% after Wednesday’s data.

Markets are now watching December more closely.

The economy is still moving
Separate data showed the US economy grew at a 2.2% annualized rate in the second quarter, up sharply from the previous estimate of 1.5%.

For investors, the message is mixed: inflation is cooling, but strong consumer spending and economic growth could keep pressure on the Fed to maintain tight monetary policy.