U.S. inflation cools in July but remains above Fed target

U.S. consumer prices rose 3.2% in the year through July, a slight deceleration from 3.3% in June, as energy costs fell while shelter and food prices continued to climb, government data showed on Tuesday.

The Labor Department's consumer price index (CPI) report indicated that inflation remains elevated despite the month-over-month decline in energy prices following a spring surge. The core CPI, which excludes volatile food and energy items, increased 3.2% year-over-year, matching the June reading.

Shelter costs, a key driver of inflation, rose 0.4% in July, while food prices increased 0.2%. Energy prices fell 2.1% over the month, contributing to the overall moderation in inflation. On a monthly basis, the CPI declined 0.1%, the first drop since May 2020.

The Federal Reserve is closely monitoring inflation trends as it considers the next steps for interest rate policy. Policymakers have signaled that further rate hikes may be necessary to bring inflation sustainably toward the central bank's 2% target.

Market expectations for a September rate hike have fluctuated in recent weeks, with traders pricing in a roughly 40% probability of a 25-basis-point increase, according to CME Group's FedWatch tool.

The latest data underscores the challenge facing the Fed in balancing inflation control with economic growth, as geopolitical tensions and supply chain pressures continue to pose risks to price stability.