Fed Keeps Interest Rates in Sights as Inflation Eases

Market expectations are shifting in favor of the Federal Reserve keeping interest rates unchanged at its upcoming policy meeting, despite renewed tensions in the Middle East and higher oil prices. The Fed's decision is scheduled for July 28-29, with investors assigning a 65.8% probability that policymakers will leave the benchmark rate in the 3.5%-3.75% range, according to CME Group's FedWatch Tool.

The June inflation data showed a decline of 0.4% from the previous month, with annual inflation slowing to 3.5%, below expectations. Core inflation, which excludes food and energy, was unchanged on a monthly basis but rose 2.6% from a year earlier. Producer prices also surprised to the downside, falling 0.3% in June while increasing 5.5% annually.

Despite softer inflation data, renewed conflict in the Middle East has pushed energy costs back into focus. Brent crude climbed to $100 per barrel last week, and the U.S. national average gasoline price rose above $4 per gallon for the first time since June, reaching $4.10 as of July 24.

Mark Zandi, chief economist at Moody's Analytics, expects the Fed to leave interest rates unchanged through this year and into next, arguing that inflation has likely peaked and inflation expectations remain well anchored. However, he warned that the outlook hinges on developments in the Iran conflict, which could force policymakers to tighten policy later this year.