Fed expected to hold rates amid high inflation and September hike risk

The US Federal Reserve is widely expected to leave interest rates unchanged on Wednesday, though the decision carries more uncertainty than policymakers have faced in years. On Tuesday night, investors were still pricing in a 32% chance of an immediate increase. The federal funds target range has sat between 3.50% and 3.75% since December 2025.

For European businesses and investors, a Fed pause offers only temporary relief from strong dollar headwinds and elevated global borrowing costs. More than three-quarters of Wall Street traders now foresee a rate hike arriving in September, according to the CME FedWatch tool. A subsequent increase would likely strengthen the dollar further, pressuring European exporters and complicating the European Central Bank's own policy calculus.

The immediate reprieve stems from a tamer-than-expected June consumer prices report, which showed headline inflation falling to 3.5% year-on-year from 4.2% in May. Core inflation dropped to 2.6%, down from 2.9% in the previous month. However, inflation has remained stubbornly above the Fed’s 2% target for over five years.

Several structural forces threaten to reverse that recent progress. Renewed Middle East tensions involving Iran have driven oil prices higher, while tariffs on foreign goods implemented by President Donald Trump continue to ripple through supply chains. Additionally, a massive surge in investment for artificial intelligence data centres is pushing up the cost of computer chips, equipment and electricity.

Fed officials have made it clear they are losing patience. Fed Chair Kevin Warsh, presiding over just his second policy meeting this week, told Congress earlier this month he had "no tolerance" for elevated inflation. Influential board member Christopher Waller was equally blunt, stating: "Sternly staring at inflation until it melts before our withering gaze is not an option."

Analysts at BNP Paribas Securities, Joseph Egelhof and Guneet Dhingra, warned that "policymakers' patience with high and persistent inflation is broadly exhausted, meaning there is a significant risk" of a hike in September. ING's Padhraic Garvey noted that while June's calming inflation data and a seeming halt to Iran hostilities support keeping rates steady, the broader US economy is showing "vulnerabilities outside of tech."

Policymakers will get fresh data to digest on Thursday when the Commerce Department releases its first estimate of economic growth for April through June, alongside the Fed's preferred inflation gauge. For Europe, these figures will be crucial in determining whether the transatlantic divergence in monetary policy is about to widen.