Inflation Ticks Up to 2.9%, but Fed Rate Cut Seems Assured as New Unemployment Claims Surge

Inflation ticked up in August in a troubling sign for consumers, but not enough to prevent a Federal Reserve interest rate cut next week as more alarm bells ring in the labor market.

Overall inflation rose 2.9% last month compared to a year earlier, up from the 2.7% rate recorded in June, according to the Labor Department's Consumer Price Index (CPI) report released Thursday.

Core inflation, which excludes volatile food and energy prices and is a key metric for Fed policymakers, was 3.1%, unchanged from July.

Both numbers were in line with what economists had expected, and were quickly overshadowed by more troubling news from the labor market that bolsters the case for Fed Chair Jerome Powell and other policymakers to cut interest rates.

A separate report on Thursday showed weekly unemployment filings, a measure of new layoffs, surging to a four-year high of 263,000. It was the highest weekly figure since October 2021, when the economy was still recovering from pandemic lockdowns.

It follows a string of alarming job reports, with sharp downward revisions to monthly and annual employment figures, a rising unemployment rate, and the number of unemployed job seekers now outnumbering job openings.

Powell and other members of the policy-setting Federal Open Market Committee are now universally expected to respond with a rate cut at their Sept. 17 meeting, but the specter of rising inflation complicates the path forward for them.

"Even though a 25 basis point cut next week seems all but certain, the combination of firmer inflation and weaker labor market data complicates the Fed’s picture going forward," says Realtor.com® Senior Economist Jake Krimmel. "With inflation above target and still rising, plus jobs momentum slipping, the Fed faces a difficult balancing act on both sides of its dual mandate."

The Fed uses higher interest rates to tame inflation, and lower rates to keep the labor marking humming, the two halves of its Congressional mandate.

Although the Fed does not set mortgage rates, those rates move in anticipation of future Fed policy and conditions in the economy.

Average 30-year mortgage rates dropped last week to an 11-month low of 6.5%, according to Freddie Mac, and have room to fall further this week following recent concerning jobs figures.

However, because a rate cut next week is essentially already baked in to mortgage rates, homebuyers shouldn't expect them to automatically fall further after the Fed makes its move.

"We should not expect rates to drop much further," says BrightMLS Chief Economist Lisa Sturtevant. "And, in fact, there is a possibility that mortgage rates could actually increase after the Fed cut. Investors may infer that the Fed has taken their eye off inflation and worry that inflation expectations are still high."

Food, energy and housings costs jump in August CPI report

Although the Fed is expected to essentially disregard the latest inflation report as it responds to brewing crisis in the labor market, the latest CPI report contains troubling news for consumers.

Overall food costs rose 3.2% annually, including a 4.9% increase in restaurant prices and a 2.7% hike in grocery bills. Prices for some consumer staples jumped an alarming amount, including beef (+14%), eggs (+11%), and coffee (+21%).

Energy costs also rose, with electricity prices up 6.2% annually and natural gas utilities up 14%. Gasoline prices rose 1.9% from July, but were still down 6.6% from a year ago.

Housing costs continued to be the biggest factor in overall monthly inflation. Rent rose 3.6% annually while owner's equivalent rent, a measure of inflation for homeowners, increased 4%.

Common household expenses also climbed higher, with water service up 4.8% annually, garbage collection rising 6.5%, and property insurance up 5.7%.

For the housing market, persistent inflation has two major implications: It erodes consumer purchasing power and puts upward pressure on mortgage rates, says the economist Krimmel.

"Higher inflation means less money left over for saving toward a down payment, further straining affordability and reducing demand for homes," he says. "On the mortgage side, renewed inflationary pressures could keep borrowing costs elevated for longer, especially if the recent 11-month low in rates simply reflects a September Fed cut already priced in."

Mortgage rates most directly reflect the yields on 10-year Treasury bonds, which typically rise in response to higher inflation as investors demand higher returns to offset eroding purchase power.

However, long-term bond yields actually fell after the new inflation report, with the 10-year dropping below 4% for the first time since President Donald Trump's "Liberation Day" tariff announcement sent financial markets into panic.

"Like the Fed, bond markets are weighing competing signals: softer jobs data that could pull long-run interest rates down versus firmer inflation that could push them up," says Krimmel. "For homebuyers and sellers, that uncertainty makes the path into the fall housing market less predictable, even if lower rates and easing uncertainty offer some relief."

Although rising layoffs and economic uncertainty may deter some homebuyers, falling mortgage rates appear to be drawing more buyers into the market, with mortgage purchase applications rising last week to their highest level since July.

"Home purchase sentiment has slipped, with more consumers expressing concern about job security and their financial outlook, but lower mortgage rates will continue to hold the key," says Krimmel.

Developing story, more to follow.