Fed July Minutes: If Inflation Doesn't Fall, Rate Hikes May Be Needed

TradingKey - The Federal Reserve released the minutes of its July meeting on August 19, Eastern Time. At the meeting held on July 28–29, the FOMC decided to maintain the target range for the federal funds rate at 3.50%–3.75%.

The minutes noted that some Fed officials believed monetary policy might need to be tightened if inflation does not decline. Some participants pointed out that the current monetary policy rate was not restrictive enough to bring inflation down to 2%.

Notably, Fed Chairman Kevin Warsh stated that scheduling six policy meetings per year—approximately once every two months—would allow more information to accumulate between meetings. Warsh then sought feedback from committee members on this idea. The minutes explicitly noted that no adjustment to the number of meetings would be made this year. Reducing the number of policy meetings would represent a significant change in how the Fed operates.

The minutes showed that Fed officials believed inflation remained elevated. Regarding the sources of inflation, the minutes provided three clear clues: the impact of prior tariff increases, the Middle East conflict pushing up energy and input costs, and demand expansion driven by AI buildouts. Participants noted marked price increases in data center-related materials such as chips and steel, while consumer and production sectors such as smartphones, computer equipment, software, and electricity also faced price pressures.

Most members expected inflation to decline over the remainder of the year as the effects of tariffs and previous energy price hikes gradually fade; however, many members also warned that inflation could prove stickier than expected. If the Middle East conflict persists, supply chains are disrupted again, or new supply shocks emerge, businesses may find it difficult to continue absorbing costs by squeezing profit margins, turning instead to passing costs on to consumers.

This means the Fed is not facing a simple energy price disturbance, but rather a situation where supply shocks and demand expansion may overlap. For inflation that has remained above the 2% target for several consecutive years, the committee was particularly concerned that inflation expectations, wage formation, and corporate pricing behavior could be pushed even higher.

Why the Fed Didn't Raise Rates Immediately

Despite upside inflation risks, a majority of FOMC members still chose to keep interest rates unchanged, reflecting a comprehensive balance between economic data and policy transmission.

The minutes showed that the U.S. labor market remained stable overall. The unemployment rate was 4.2% in June, showing little overall change over the past two years; nonfarm payroll growth slowed in June, but average monthly job gains in the first half of this year were still significantly higher than the 2025 average. Average hourly earnings grew 3.5% year-over-year, down 0.4 percentage points from a year ago.

Regarding economic activity, the staff judged that real GDP growth slowed in the second quarter, but real private domestic final purchases, which better reflect underlying momentum, picked up and grew faster than GDP. Consumer spending strengthened, and AI buildout continued to support business investment; high-tech trade remained active, while energy exports stayed high due to Middle East oil transport disruptions.

The FOMC is facing an atypical combination: the labor market has not deteriorated significantly, consumption and investment remain resilient, yet inflation has not returned to the target. Most members believed that continuing to monitor data before the next meeting would allow for a clearer assessment of the persistence of energy shocks, tariff impacts, and the AI investment boom on inflation, thereby reducing the risk of policy misjudgment.

AI Investment Becomes New Variable for the Fed: Could Push Up Inflation and Boost Productivity

AI-related investment was repeatedly mentioned in the minutes of this meeting. The Federal Reserve noted that the stock performance of the AI infrastructure sector year-to-date has outperformed the S&P 500 Index and hyperscale cloud computing enterprises.

In the real economy, AI buildout continues to drive corporate investment and has increased demand for skilled labor such as electricians, machinists, and engineers, pushing up wages in related positions. Some participants noted that the impact of AI investment on consumer prices remains concentrated in a few categories for now, while others judged that AI buildout has already exerted a broader impact on prices by pushing up aggregate demand, or may do so shortly.

The significance of AI for monetary policy lies in its "two-way nature." On the one hand, large-scale investments in computing power, data centers, chips, electricity, and related equipment could drive up demand, financing needs, and certain factor prices in the short term. On the other hand, if AI applications lead to productivity gains and potential output expansion, they could reduce production costs, increase supply, and exert downward pressure on inflation over the long term.

However, the minutes also explicitly pointed out that significant uncertainty remains regarding when and to what extent productivity effects will materialize. Some participants noted that if AI development or profitability expectations prove disappointing, tech stocks could experience a massive repricing, weighing on consumption and financial conditions through the wealth effect.