August, 2025
Our economy is large and complex. Assessing its health and likely path requires examining many different measures, all of which are interconnected to some degree. One of the most relevant variables is the rate of inflation.
In its most basic form, rising prices stem from too many dollars (i.e. demand) chasing too few goods and services (supply).
Other factors, such as tariffs, can also have a significant impact. There are currently differing schools of thought about the outlook for inflation among both economists and investors, creating heightened uncertainty.
Inflation is not yet on a glidepath to the 2% level that the Federal Reserve would like to see before lowering interest rates further, but price increases have mostly remained calm in the early months of the Trump administration. Consumer prices in June jumped by 2.7% year-over-year from 2.4% in May. Core inflation, which removes the more volatile cost of food and energy, also increased by a tenth of a percentage point to 2.9%. While these increases were in line with the expectations of economists, they rose by the swiftest pace since February.
Tariff impacts are beginning to appear in the data. Prices of household furnishings, appliances, toys and apparel (items that tend to be sensitive to tariffs) experienced larger increases in June. This was offset by new and used car prices unexpectedly falling, possibly due to consumers having moved planned purchases ahead in prior months to avoid anticipated tariff-related price increases.
Despite rising goods prices, slower price increases for services such as rent helped keep overall inflation low. There has also been a pullback on discretionary spending, such as travel. Hotel and motel prices saw a much steeper drop than in prior months and airline fares fell slightly.
Continued tariff threats make it more challenging to decipher where inflation is headed. Many economists agree that tariffs raise prices and hurt economic growth. However, the size of the impact and timing of additional price increases remain murky. Some others argue that tariffs will not create sustained inflation, as the economy and corporate pricing power aren’t strong enough to support broad price increases.
Federal Reserve policymakers are just as divided and continue to maintain a wait-and-see approach before making additional interest rate adjustments. In addition to the impact from tariffs on the economy, they are also closely monitoring the health of the labor market. A few Fed decisionmakers are advocating for the resumption of rate cuts in the very near-term, while others believe it may not be appropriate to reduce rates at all this year. The majority expect to cut rates this year, but the anticipated timing and magnitude vary considerably amongst them.
Interestingly, consumer expectations for inflation have declined recently. Survey respondents expect prices to increase by 4.4% over the coming year. That’s a decline from the 5% expected last month, but up from the 3.3% rise expected in January.
The link between inflation and interest rates is clear, but inflation’s economic impact goes well beyond that. Inflation reduces purchasing power, as each dollar buys less, which negatively impacts consumer spending and slows economic growth. Higher prices can also ignite a wage-price spiral, where workers demand more money and businesses are forced to raise prices, creating more inflation. Higher interest rates from increased inflation are also a drag on the economy, as well as asset values such as stock and bond prices.
We clearly have much riding on the rate of inflation and its trajectory. Recent levels have been tame but rising. The tariff issue remains, but it hasn’t weighed on economic growth or boosted inflation yet as much as was widely feared (as it’s not something we’ve experienced in recent history). The resulting level of interest rates and full effect on economic growth remain unclear.
We should get a better idea of where things stand in the next few months as additional data rolls in, decisions are made, and policy is firmed up. Stocks like clarity and investors may already be embracing the idea now that answers could arrive soon.
