Annual U.S. inflation held steady in July well above the Federal Reserve’s 2% target for the 65th straight month, and the unexpected pause in the decline from a recent war-induced peak is likely to intensify the central bank’s debate over whether interest rates should be lifted or held steady.

Government data released on Wednesday also showed consumer spending decelerating modestly last month — and flatlining against inflation — while personal incomes rose faster than inflation, which could foreshadow an uptick in consumption as the year progresses.

Meanwhile, orders of major capital goods rebounded last month, led by transportation equipment orders, and shipments of durable goods outside the defense and aerospace sectors pointed to continued brisk business investment in the artificial intelligence space. Corporate profits rose at the second-fastest pace on record in the second quarter.

The clutch of reports together point to an acceleration in overall economic growth in the third quarter and should keep the Fed’s focus squarely on containing inflation, economists said.

“The July consumer spending and core durable goods shipments data point to a strong real GDP (gross domestic product) growth rate in Q3 that looks to be running at least 3%,” said Kathy Bostjancic, chief economist at Nationwide. That figure would be double the second quarter’s unrevised annualized growth rate of 1.5%.

The data blitz occurred just two days before Fed Chairman Kevin Warsh delivers his debut keynote speech to the Kansas City Fed’s annual economic symposium in Jackson Hole, Wyoming, an event global investors are keenly awaiting — particularly those in an inflation-wary government bond market.

“As Jackson Hole beckons, the Fed’s challenge is clear: It still has considerable ground to cover before markets see 2% inflation as a credible outcome rather than a distant aspiration,” said Olu Sonola, head of U.S. economics at Fitch Ratings.

Above-Forecast Annual Inflation

The Personal Consumption Expenditures Price Index increased 3.7% in the 12 months through July, unchanged from June, the Commerce Department’s Bureau of Economic Analysis said. Economists polled by Reuters had forecast a reading for PCE, which the Fed uses to set its target, of 3.6%.

The month-over-month figure also was higher than expected at 0.2% in July after falling 0.1% in June, which had been the weakest reading since April 2020. Economists had forecast a 0.1% increase.

Excluding energy and food prices, so-called core PCE — which Fed officials use as a guidepost for inflation’s underlying run rate — held steady at 3.3% on the year while rising to 0.2% on the month from 0.1% in June.

The above-forecast headline print gave a modest lift to expectations that the Fed may raise interest rates as soon as next month. Fed funds futures prices reflected about a 40% probability of a rate hike at the central bank’s September 15-16 meeting after the report, versus about 36% immediately before.

“This is data that supports a hike,” said Omair Sharif, founder and president of forecasting firm Inflation Insights. “The unrounded core PCE was 0.246%, so it barely missed out on rounding to 0.3%. That is a one-month annualized rate (of) nearly 3.0%.”

War and Tariffs Cloud Inflation Outlook

Annual PCE shot to a three-year high of 4.1% in May after the U.S. and Israel launched air strikes against Iran in late February, sending energy prices higher as the conflict shut in roughly a fifth of global oil supplies.

Six months later, the conflict appears no closer to a final resolution, though the exchange of fire has diminished and oil prices and inflation more widely have retreated from mid-spring highs.

The slowdown in inflation has helped buoy arguments by the majority of Fed policy committee members who voted last month to leave the central bank’s benchmark interest rate unchanged in the 3.50%-3.75% range, where it has been since December. But the sluggish pace of improvement is unlikely to mollify a growing minority of policymakers who argue tighter policy is needed, given that inflation has been above target since February 2021 and will not get to the 2% level without further restraint.

Inflation as measured by PCE peaked at 7.2% in June 2022, and the steepest Fed rate increases since the 1980s helped put it on a path back toward 2%. That trajectory changed last year after President Donald Trump unleashed a wave of import tariffs upon his return to the White House, sending a wide range of goods prices higher, with the Iran war exacerbating those pressures.

And new tariff-induced pressures are likely coming, after trade negotiations between the U.S. and its second-largest trading partner, Canada, fell apart on Friday, resulting in new levies on $20 billion of Canadian imports to go into effect.

GDP Update Shows Corporate Profits Boom

The BEA on Wednesday also left unchanged its estimate of annualized gross domestic product growth for the second quarter at 1.5% but revised up consumer spending to 3.4% from the originally reported 3.2%, an indication that the individual consumption that supports two-thirds of U.S. economic activity had held up through the first half of the year.

Business investment remained strong, driven by continued growth in AI spending. Growth in final sales to private domestic purchasers, which measures the combined outlays of consumers and of businesses on investment and is a key indicator of overall private consumption, was revised up to 4.2% — the highest since the first quarter of 2023 — from 3.9%.

Corporate profits jumped by $400.9 billion after climbing by $74.4 billion in the first quarter. The latest reading was the second-largest increase in profits on record — topped only by the third quarter of 2020 — and was likely driven by Trump’s corporate tax overhaul that went into effect this year.

There was also an improvement in growth as measured from the income side. Gross domestic income rose 2.2% versus 1.2% in the first quarter. The average of GDP and GDI, also referred to as gross domestic output and considered a better measure of economic activity, grew at a 1.8% rate versus 1.7% in the previous quarter.

(Reporting by Dan Burns, Michael S. Derby and Ann Saphir; Editing by Chizu Nomiyama and Paul Simao)