Fed rate hike odds surge to 90% on monthly jump in core prices

A fresh reading on inflation showed monthly prices rose more than expected in August, increasing the likelihood the Federal Reserve will raise interest rates next week.

A rebound to oil at $100 per barrel also complicates the picture.

Stripping out volatile food and energy prices — the way the Fed likes to scrutinize underlying inflation — the Consumer Price Index rose 0.3% month over month , compared with expectations for 0.2%. The year-over-year rate was in line with expectations for 2.4% and down a tenth of a percentage point from July. On a headline basis, CPI rose 3.4% in August, in line with expectations, and 0.4% month over month.

"The upside surprise to core CPI in August means the Fed looks set to hike next week," said Stephen Brown, North America chief economist for Capital Economics.

Markets are now betting on a 90% chance of a rate hike at Wednesday's Fed policy meeting, according to CME FedWatch .

Officials will use the latest inflation data to examine trends over the past three, six, and 12 months to assess whether price pressures are easing.

Fed officials have been divided about whether inflation is falling back down to their 2% goal on its own or whether they need to raise rates. Friday's data will fuel hawks like Cleveland Fed president Beth Hammack and Dallas Fed president Lorie Logan, who argue that inflation is broad-based and that without increasing rates, it won't come down on its own.

It may also not be enough to satisfy officials like Fed governor Chris Waller, who said last week that if August figures show inflation coming down and core prices staying at 0.2%, he would support holding rates steady next week.

"If there is continued progress toward our 2% goal, then I am willing to support holding the policy rate at its current level," Waller said on Sept. 3. "But if inflation comes in hot, I would consider a rate hike. I judge that policy is currently only slightly restricting aggregate demand, and it may not take much acceleration in inflation to nudge me into supporting tighter policy."

Fed Chairman Kevin Warsh said in a speech at Jackson Hole, Wyo., last month that inflation is too high and that rates are not restricting borrowing in the economy, outside of housing. He noted that June and July inflation readings, which had shown some progress, hadn't been enough for him to mark the improvement he needs to see that inflation is coming down.

"Following a brief easing in June and July, inflation surged again in August which sets the stage for a likely interest rate hike," RSM chief economist Joseph Brusuelas said. He expects the Fed to hike at least two more times after next week over the next year to put inflation on a credible path back to 2%.