What to expect from this Friday's inflation report

An inflation report released on Friday could confirm that inflation has lost bite and provide an outlook on how quickly and how far the Federal Reserve's benchmark interest rate will fall in the coming months.

A report from the Bureau of Economic Analysis on Friday is likely to show that consumer prices, as measured by personal consumption expenditures, rose 0.1 percentage point in July from June, according to economists surveyed by Dow Jones Newswires and The Wall Street Journal. This would be the same monthly increase as in June and would correspond to a year-on-year inflation rate of 2.5%, the same as the previous month.

Forecasters expect the PCE inflation report released Friday to be consistent with what another report from earlier this month, the Consumer Price Index, showed about the trend in consumer price increases: The cost of living has continued to rise only moderately in recent months after a worrying upward trend in the first quarter and is on track back toward the Federal Reserve's target of 2% annually.

Falling inflation, lower Fed interest rates

The report will likely be closely watched by Fed officials who set the benchmark interest rate. That rate influences rates on all types of loans, including mortgages, credit cards and auto loans. Fed officials rely on PCE inflation to judge how high to set the benchmark interest rate and will use it to gauge how quickly to cut rates in the coming months.

Fed officials, including Fed Chairman Jerome Powell, have said they are preparing to cut the benchmark interest rate in September. Data from the PCE report and other inflation indicators over the past few months have convinced policymakers that price increases have shown that inflation is firmly on track to fall to 2%. Policymakers are shifting their focus from trying to slow the economy with high interest rates to curb inflation. Instead, they plan to cut interest rates to stimulate the economy and prevent unemployment from rising.

A key question for financial markets is whether the Fed will open its campaign with a 0.5 percentage point cut from current levels of 5.25 to 5.5 percent or opt for a less aggressive quarter-percentage point cut.

The PCE report is unlikely to clarify this question, said economists at Deutsche Bank in a commentary. Rather, the Bureau of Labor Statistics' labor market report, which will be published on September 6, will have a greater influence on central bankers – a rise in unemployment could lead to a greater interest rate cut.