Fed Rate-Hike Case Builds as Inflation Fails to Cool

Sept 11 (Reuters) - Back-to-back hotter-than-expected inflation readings may disappoint the majority of U.S. central bankers who had been counting on price pressures easing on their own, setting the table for an interest-rate hike at the Federal Reserve's meeting next week and potentially more to follow.

U.S. consumer price inflation excluding energy and food, a key measure of underlying inflation, rose 0.3% last month from the previous month, the Bureau of Labor Statistics reported, more than the 0.2% that economists had anticipated. From a year earlier, core CPI rose 2.4%, while overall consumer inflation measured 3.4%.

Coupled with a stronger-than-expected August producer price index released on Thursday and oil prices that have soared above $100 a barrel amid renewed hostilities in the Middle East, the latest data suggest inflation by the Fed's targeted measure, above the target 2% for 5-1/2 years, is again moving in the wrong direction.

"Today’s clean 0.3% core CPI print, combined with the sharp rise in energy prices and persistent tensions with Iran, all but locks in a Fed rate hike next week," wrote Principal Asset Management chief global strategist Seema Shah. "After half a decade of above-target inflation, policymakers are likely to conclude that more than one hike will be needed to re-establish price stability."

The Fed has left its policy rate in the 3.50%-3.75% range all year, including in a 9-3 vote in July that signaled rising sentiment inside the Fed that higher rates were already needed. Last month at the Kansas City Fed's annual gathering in Jackson Hole, Wyoming, Fed Chairman Kevin Warsh said he and his fellow central bankers may need to act if they don't have confidence that underlying inflation is moving toward 2% "clearly and at sufficient speed."

Economists Friday said the August data does not appear to meet that bar.

"For the Fed, it is time to put up, or shut up," Inflation Insights founder Omair Sharif wrote. "You cannot give a speech like you did at Jackson Hole and not support a rate hike at the next meeting. You will either have to back up those words or end up as the boy who cried wolf."

Not all economists agree. The Fed targets 2% inflation by the 12-month change in the personal consumption expenditures price index, which weights some items, including some AI-related prices, more heavily than the CPI. Friday's CPI data showed software and accessories prices declined, and core goods prices decelerated. Pointing to those figures, Oxford Economics analysts estimate core PCE for August likely rose a "benign" 0.2%, allowing the Fed to skip a rate hike next week.

But, they added, the decision is on a "knife's edge."

Several other economists forecast a higher core PCE reading which they say would likely stoke concern among Warsh's colleagues who had expressed expectations that cooling inflation in June and July was the start of a welcome trend. At least two Wall Street firms now newly forecast a rate hike next week, having previously expected a hold.

"This call reflects the inflation data, but also the market expectations as Chairman Warsh will want to avoid a dovish surprise next week," Piper Sandler analysts wrote.

Traders of short-term interest-rate futures are now pricing about an 85% chance of a quarter-point increase at the Fed's September 15-16 meeting, versus about 70% before the report. Market pricing points to expectations for a second rate hike in December.

"We don’t think today’s print portends a reacceleration of core inflation, but merely a bump on the disinflationary road," wrote Natixis economist Christopher Hodge. "We think a nudge via a hike or two is probably what the Fed will think is appropriate, starting with a hike next week."