Latest inflation data shows that August's month-on-month price increase exceeded market expectations, significantly increasing the likelihood of a Federal Reserve rate hike next week. The record high of over $6 per gallon in U.S. diesel prices further complicated the situation. The Federal Reserve tends to exclude volatile food and energy prices when assessing potential inflation levels. Core CPI rose 0.3% month-on-month in August, higher than the market expectation of 0.2%; core CPI rose 2.4% year-on-year, in line with expectations, but down 0.1 percentage point from July. Overall CPI rose 3.4% year-on-year in August, in line with expectations, and rose 0.4% month-on-month. Stephen Brown, chief economist for North America at Capital Economics, said: "The stronger-than-expected rise in core CPI in August means that the Federal Reserve is likely to start raising interest rates next week." According to the CME Group's FedWatch Tool, the market is now betting on a near 90% probability of a rate hike at Wednesday's policy meeting. Fed officials will analyze the price trends over the past 3, 6, and 12 months, using the latest inflation data, to determine whether price pressures are easing. There is already internal disagreement within the Fed regarding whether inflation can fall back to the 2% target on its own or whether further rate hikes are necessary. Friday's inflation data will provide strong support for hawkish officials such as Cleveland Fed President Beth Hammark and Dallas Fed President Lori Logan. These two hawkish officials believe that inflation is widespread and will not decline on its own without further rate hikes. However, this data may still not convince officials like Fed Governor Chris Waller. Waller stated last week that if inflation cools in August and core prices remain at 0.2% month-over-month, he would support keeping interest rates unchanged next week. Waller stated on September 3rd, "If inflation continues to make progress toward the 2% target, I'm willing to support maintaining the policy rate at its current level. But if inflation data is strong, I would consider supporting a rate hike. In my view, current monetary policy is only slightly suppressing aggregate demand, and even a slight acceleration in inflation would be enough to prompt me to support tightening monetary policy." Federal Reserve Chairman Kevin Warsh stated last month that inflation remains too high, and that interest rates, except in the housing sector, are not constraining economic lending. He pointed out that while inflation showed some improvement in June and July, this was not enough to convince him that inflation was consistently declining. RSM Chief Economist Joseph Brusuelas said, "After a brief easing of inflation in June and July, inflation rebounded again in August, paving the way for a likely rate hike by the Fed." He predicts that after next week's rate hike, the Fed will raise rates at least twice more in the next year to credibly push inflation back to the 2% target. New York Fed President John Williams stated that if the monthly reading of the Personal Consumption Expenditures (PCE) price index, a key inflation gauge monitored by the Fed, continues to remain at 0.2% month-over-month, it indicates that inflation is cooling. Fed officials will combine the CPI with the Producer Price Index (PPI) released on Thursday to estimate PCE inflation. Capital Economics' Brown estimates that core PCE rose 0.27% month-over-month in August; even with subsequent revisions to the statistical methods for portfolio management, software, and accessories prices, this figure will not change significantly. Without considering statistical revisions, this estimate means that core PCE year-over-year will rise from 3.3% in July to 3.4%. Brown stated, "In short, core PCE inflation is moving in the wrong direction, which is enough to convince centrists on the Federal Open Market Committee, such as Governor Chris Waller, to support a rate hike next week." A New Round of Oil Shocks The sharp rise in oil prices over the past week is also reshaping the Fed's policy game. Krishna Guha, head of central bank strategy and economics at Evercore ISI, stated, "The core issue at the policy level is no longer whether the August CPI confirms the improvement in summer inflation; rather, whether this improvement is enough for the Fed to ignore a new round of oil supply shocks—this round of shocks has had a particularly significant impact on diesel and other refined oil products." According to traditional policy logic, the Fed typically ignores oil price shocks and focuses on underlying inflation trends. However, inflation has been above the 2% target for five and a half years; coupled with multiple shocks—tariffs, the Russia-Ukraine conflict, and the COVID-19 pandemic—it's difficult for the Fed to continue simply ignoring the impact of rising energy prices. Bruzuelas believes that in the face of supply shocks caused by war, the Fed should "abandon textbook old thinking." He stated that the successive rounds of supply shocks have lasted long enough to no longer be simply characterized as temporary shocks. He pointed out, "Optimal monetary policy should be forward-looking. What was originally considered a short-term conflict has lasted for seven months; its nature has changed, and the Fed needs to make a rational policy response." However, among Fed watchers, there remains a camp advocating for maintaining interest rates unchanged. In an interview, Luke Tilly, chief economist at Wilmington Trust, said, "This CPI report alone almost guarantees a Fed rate hike in September. But I still believe the economic data does not support a rate hike; more broadly, the CPI data does not show inflation driven by strong consumer demand. It's fair to say the Fed has almost driven itself into a policy dead end."