In a setback for the US Federal Reserve and the Donald Trump administration, annual inflation in the world’s largest economy held steady in July well above the central bank’s 2% target.
While the phenomenon has continued for the 65th straight month, the recent Iran war-induced peak is likely to intensify the debate within the Fed’s policy circles over whether interest rates should be lifted or held steady.
As per the latest government data, consumer spending decelerated modestly last month, while flatlining against inflation. However, one positive aspect is the faster increase in personal incomes compared to inflation, which could lead to a rise in consumption as the year progresses.
Orders for big-ticket items bounced back in July, mainly due to more orders for transportation equipment, and the rise in shipments of long-lasting goods outside the defense and aerospace areas suggests that investments in artificial intelligence (AI) are still growing. Corporate profits rose at the second-fastest pace on record in the Q2 2026.
As per the economists, the reports, if taken together, point to an acceleration in overall economic growth in the Q3. However, the Fed’s current focus should be on fighting inflation, as the crucial midterm elections are approaching.
“The July consumer spending and core durable goods shipments data point to a strong real GDP (gross domestic product) growth rate in Q3 that looks to be running at least 3%. That figure would be double the second quarter’s unrevised annualized growth rate of 1.5%,” said Kathy Bostjancic, chief economist at Nationwide.
All eyes will be upon Fed Chairman Kevin Warsh, who will deliver his debut keynote speech to the Kansas City (State of Missouri) Fed’s annual economic symposium in Jackson Hole, Wyoming, this weekend. Investors, particularly those operating in the inflation-wary government bond market, will be looking forward to the vent.
“As Jackson Hole beckons, the Fed’s challenge is clear: It still has considerable ground to cover before markets see 2% inflation as a credible outcome rather than a distant aspiration,” said Olu Sonola, head of US economics at Fitch Ratings.
Coming back to the July data, the “Personal Consumption Expenditures Price Index” increased 3.7% in the 12 months through the month, unchanged from June, the Commerce Department’s Bureau of Economic Analysis said.
At 0.2% in July, the month-over-month consumption figure was also higher than expected after falling 0.1% in June, which had been the weakest reading since April 2020.
Excluding energy and food prices, so-called core PCE (Personal Consumption Expenditures), which Fed officials use as a guidepost for inflation’s underlying run rate, held steady at 3.3% on the year while rising to 0.2% on the month from 0.1% in June.
Immediately after the data’s publication, Fed funds futures prices reflected about a 40% probability of an interest rate hike at the central bank’s September 15-16 meeting, versus about 36% right before.
“This is data that supports a hike. The unrounded core PCE was 0.246%, so it barely missed out on rounding to 0.3%. That is a one-month annualized rate (of) nearly 3.0%,” said Omair Sharif, founder and president of forecasting firm Inflation Insights, while interacting with the Reuters.
Annual PCE shot to a three-year high of 4.1% in May after the beginning of the Iran war, sending energy prices higher as the conflict shut in roughly a fifth of global oil supplies through the strategically important maritime trade route known as the Strait of Hormuz.
More than six months down the line, while the conflict has shown no signs of a final resolution, oil prices and inflation more widely have retreated from mid-spring highs, as the warfare moves on from the battlefield to the economic arena, with Washington unveiling its sanctions package against Tehran.
Talking about the Fed’s monetary policy direction, the central bank, in July, left its benchmark interest rate unchanged in the 3.50%-3.75% range, where it has been since December 2025.
However, a growing minority of policymakers still believe that a tighter policy is needed, given that inflation has been above target since February 2021 and will not get to the 2% level without further restraint.
Inflation as measured by PCE peaked at 7.2% in June 2022, and the steepest Fed rate increases since the 1980s helped put it on a path back toward 2%.
However, President Donald Trump’s second term at the White House began with a flurry of import tariffs on both the United States’ partners and adversaries, drastically changing the situation and leading to a wide range of goods being priced higher. The Iran war has further boosted those price pressures.
The broken trade negotiations between the United States and its second-largest trading partner, Canada, resulted in new levies on USD 20 billion of Canadian imports, which will also increase the pain.
At this backdrop, the BEA has left unchanged its estimate of annualised GDP growth for the Q2 at 1.5% but revised up consumer spending to 3.4% from the originally reported 3.2%, an indication that the individual consumption that supports two-thirds of American economic activity had held up through the first half of the year.
Business investment remained strong, with continued growth in AI spending negating the tariff warfare-related pressure to some extent.
Growth in final sales to private domestic purchasers, which shows how much consumers and businesses spend on investments and is an important sign of overall private consumption, was revised up to 4.2%, the highest since Q1 2023, from 3.9%.
Corporate profits jumped by USD 400.9 billion after climbing by USD 74.4 billion in the first quarter. The ratio became the second-largest increase in profits on record, topped only by the third quarter of 2020, and was likely driven by the Trump administration’s corporate tax overhaul that went into effect this year.
Gross domestic income (GDI) rose 2.2% versus 1.2% in the first quarter. The average of GDP and GDI, also known as gross domestic output and considered a better measure of economic activity, grew at a 1.8% rate versus 1.7% in the previous quarter.