Persistent Inflation Pressures Amid Iran Conflict and US Trade Tensions

POLICY WIRE — Washington, USA — A critical inflation indicator closely monitored by the Federal Reserve remained elevated last month, signaling ongoing financial strain for many Americans.

The persistent high prices are emerging as a significant concern in the upcoming midterm elections, just 10 weeks away. This is especially true as the Iran war sustains high gas prices, President Donald Trump threatens new tariffs on Canada and China, and increased spending on AI infrastructure drives up costs for computers, gaming consoles, and semiconductors.

Inflation stayed high in July despite a drop in gas prices, largely due to a surge in the cost of services such as healthcare, utilities, and financial services. However, the government intends to modify how it calculates the cost of certain services starting next month, which might result in lower reported inflation.

The Commerce Department reported on Wednesday that prices increased by 3.7% in July compared to the previous year, consistent with June’s figures. Inflation has escalated since the U.S. and Israel’s attack on Iran in late February, when it was at 2.9%. This is significantly above the Fed’s target of 2%.

These figures are derived from the personal consumption expenditures price index, distinct from the more commonly followed consumer price index reported earlier this month. The PCE index is currently higher than the CPI, partly because it places less emphasis on rental costs, which have been gradually decreasing in recent months.

Excluding the volatile food and energy categories, core inflation remained steady at 3.3% in July. It had dropped to 2.6% before President Donald Trump introduced extensive tariffs in April 2025.

On a monthly basis, prices increased by 0.2% from June to July, following a 0.1% decline the previous month and a 0.5% jump in May. Core prices also rose by 0.2% from June to July, up from 0.1% in the prior month. Some Fed officials view a core inflation rate of about 0.2% per month as a positive sign that inflation is returning to the 2% target.

Many economists have pointed out that the PCE index has been inflated by its method of calculating the cost of financial advice and measuring prices for software and computer accessories. When stock markets rise, this results in larger gains in what the government terms “portfolio management services.” However, this measure does not always accurately reflect what Americans actually pay for financial services.

Simultaneously, the PCE likely includes some business-related spending on software, even though it should only focus on consumer spending, analysts say.

Consequently, the Commerce Department has announced plans to adjust these measurements, among others, starting next month. Economists, who generally agree with the changes, predict that they will reduce annual PCE inflation by approximately 0.2 percentage points.

Although inflation has decreased from its post-pandemic peaks—reaching 7% according to the Fed’s preferred gauge in 2022—consumer sentiment surveys indicate that most Americans remain pessimistic about the economy and their finances.

A major reason for this is likely that inflation, even at lower levels, has diminished incomes. Wednesday’s data revealed that inflation-adjusted incomes have increased by only 0.2% compared to a year ago, following several months of decline.

Moreover, gas prices have risen again this month, which will probably increase inflation when the August figures are reported next month. Prices have ticked up overnight to an average of $4.10 per gallon nationally, according to AAA.

Consumers did increase their spending at a robust pace in the April-June quarter, according to a separate report released Wednesday, and businesses also significantly increased their investments, largely on the AI infrastructure buildout. The economy grew by just 1.5% during the second quarter, however, as much of the business spending went towards imports.

But Americans may be becoming more cautious as inflation remains high. Consumer spending, adjusted for inflation, was unchanged in July, the government said Wednesday.

The new inflation data is unlikely to fully resolve the division at the Fed, where most officials are willing to maintain interest rates steady to see if inflation can cool on its own. However, many Fed officials have advocated for raising rates in an attempt to slow borrowing and spending to combat higher prices.

New Fed Chair Kevin Warsh will deliver a high-profile speech on Friday in Jackson Hole, Wyoming, which will be closely watched by Wall Street for any indications of his thoughts on next steps.

Persistent inflation has contributed to higher long-term interest rates, which have increased borrowing costs for mortgages, auto loans, and credit cards. Many Wall Street analysts say that a lack of clarity from Warsh about how the Fed will respond to persistent inflation has also driven up these rates. The yield on 30-year Treasury bonds briefly reached a 19-year high earlier this month, prompting an unusual intervention by Treasury Secretary Scott Bessent.

Bessent announced that the Treasury would double its buybacks of longer-term bonds—those lasting for 10 to 30 years—starting next month. Such a move would theoretically raise Treasury prices and lower yields. The announcement initially had little effect, though yields have since declined slightly.

Reporting by Policy-Wire (PW)