The Fed is almost certain to raise interest rates at its policy meeting next week, but faces a growing dilemma over its plans for the rest of the year. Core inflation has dropped back recently, while at the same time the unemployment rate has fallen further. We doubt the Fed will be willing to ignore the rapid progress on the employment side of its dual mandate, and expect it to raise rates in both September and December as well.
Admittedly, part of the recent weakness in core CPI inflation is due to temporary factors. But there are other reasons to expect it to rise only gradually – from 2% this year to 2.5% in 2018. Nonetheless, if the unemployment rate falls below 4% soon, as the survey evidence suggests it will, the Fed won’t wait for a more marked rebound in inflation to press ahead with further rate hikes.
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