Can interest rate hikes tame US inflation? The CPI report sets the tone for next week's decision by the Federal Reserve, but tariffs, oil prices, and AI investment may doubt the effectiveness of the policy

The Zhitong Finance App has learned that Federal Reserve officials have previously sent a signal saying they are ready to raise interest rates if inflation does not improve soon. However, according to some analysts, they may find later that in the face of the multiple factors currently driving up prices, the deterrent effect of this core policy tool is very limited.

The Consumer Price Index (CPI) report to be released on Friday will determine whether policymakers will raise interest rates next week. Officials stressed that they need hard evidence that potential inflation is falling towards the Federal Reserve's 2% target. According to futures contracts, investors currently expect the possibility that the Federal Reserve will raise interest rates at the September 15-16 meeting at about 60%.

“Key drivers for inflation above trend levels are war in Iran, tariffs, and chip shortages. Even if the Fed raises interest rates once or twice, it is unlikely to fundamentally change this background,” said Stephanie Ross, chief economist at Wolfe Research.

The two main drivers of inflation this year — tariffs and energy prices — tend to be particularly insensitive to interest rates. The third factor, artificial intelligence (AI) infrastructure construction, also appears to be insensitive to interest rates, given the billions of dollars of investment flowing into the sector. At the same time, concerns about continued high inflation and growing government debt have boosted borrowing costs for American households.

According to the median forecast of a survey of economists, the August CPI report is expected to show overall inflation rising 0.4% month-on-month and core inflation rising 0.2% month-on-month.

Before the data was released, the signals sent by Federal Reserve officials were conflicting. Some officials argued that it was time to raise interest rates, while others believed that the pressure on prices was easing.

Below is a breakdown of the causes of the current round of inflation and how interest rate hikes will affect the overall economy.

Supply shocks

Central banks usually raise interest rates to raise borrowing costs, reduce aggregate demand, and curb inflation. However, interest rate hikes are inadequate to deal with a series of recent supply shocks that have driven up prices and reignited inflationary pressure.

The outbreak of the war in Iran in February pushed global oil prices to over 100 US dollars per barrel, raised fuel costs, and boosted overall inflation. High energy prices are one reason why the overall CPI for August is expected to rise compared to the previous month.

Trade policies, on the other hand, created another shock by increasing the cost of overseas goods and reducing their supply. US President Trump announced full tariffs in April 2025 as part of a series of measures to set up trade barriers. These initiatives have evolved over a series of court challenges and ongoing negotiations with other countries.

Many Federal Reserve officials believe that the worst phase of the impact of tariffs is over, but they are still wary of evidence that price pressures are becoming more common — if this happens, the need to raise interest rates may increase.

“Available evidence suggests that the impact of tariffs on prices has spread to a large extent to inflation, and my earlier fears that rising energy prices would penetrate the prices of many goods and services have not occurred, at least so far,” said Federal Reserve Governor Christopher Waller.

Artificial intelligence and construction

High interest rates are dragging down the housing market, but the boom in demand for data centers and critical components has had little effect.

Residential construction employment has been on a downward trend since September 2024, as high interest rates and high housing prices hit sales. But overall construction employment hit a record in August, as non-residential professional recruitment and engineering construction rebounded — probably reflecting the impact of AI.

According to J.P. Morgan Chase, data center capital investment announcements continue to surge, and the scale of related investments may reach 5.5 trillion US dollars by 2030.

Economists at Barclays say this AI “buffer” is making the work of the Federal Reserve more complicated because it blocks a traditional monetary policy mechanism: the housing slowdown triggers layoffs in the construction industry and has a ripple effect in the economy. Back in 2022, home sales fell sharply as the Federal Reserve raised interest rates. Since then, sales have been hovering at a sluggish level.

“The economy is far less sensitive to interest rates than in previous cycles,” said Ajay Rajadiaksha, Barclays Global Research Chairman.

Barclays analysis found that hyperscale cloud service providers spend more than 90% of their operating cash flow on AI infrastructure. “They are unlikely to reconsider their spending plans because the cost of data center financing has risen by 50 to 75 basis points,” Rajadiaksha and Barclays chief US economist Mark Giannoni wrote in a report.

Consumer spending and borrowing

Given that many of the recent drivers of inflation are likely to be limited by interest rate hikes, Federal Reserve officials may have to put more pressure on one component of the economy that is more directly affected by rising borrowing costs: consumers.

Even though the Federal Reserve has yet to raise interest rates, American households are already feeling the pressure as the market spontaneously pushes up borrowing costs. The 10-year US Treasury yield rose to its highest level since 2023 on Wednesday. Meanwhile, mortgage interest rates hit their highest point in more than a year last week.

Christopher Hodge, chief US economist at Natixis, said that while actual income is flat, interest rate hikes may “put downward pressure on discretionary spending, thereby slowing growth slightly.”

What needs to be made clear is that the Federal Reserve simultaneously has the dual mission of stabilizing employment and controlling inflation. Hodge said that while the unemployment rate is still low, officials are under pressure to act on inflation, but it is not easy to make the right judgments.

“The pressure is on the side of inflation data, and we must show a convincing performance,” he said. “Unless it is clear once again that improvements in inflation are progressing, any sign that less than this will prompt interest rate hikes next week.”