Federal Reserve signals inflation risk outweighs labor concerns in U.S. outlook

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Fed signals inflation risk outlook

Highlights

Federal Reserve's Cook emphasizes inflation as the greater risk to the U.S. outlook, with the price index rising 3.7 percent in the 12 months through June and core goods prices increasing at a 5 percent annual pace in 2024.
FOMC projects 2025 GDP growth at 2.0 percent and 2026 at 2.2 percent—both above last year's forecasts—while annual labor productivity rose about 2.5 percent over the past two years.
Cook cites more than $1.5 trillion in announced data center investment and recent supply shocks, such as higher energy and AI infrastructure spending, as persistent inflation drivers keeping Fed rate policy cautious.

Policy outlook shifts as inflation stays elevated

As reported by the Federal Reserve Board, Cook says recent data are changing how she views the central bank's dual mandate, with inflation now posing the greater risk. She says the unemployment rate stands at 4.2 percent in June, broadly in line with the past year, while claims for unemployment benefits remain low, payroll growth is moderate and job openings have picked up in recent months.

Cook contrasts that backdrop with the outlook a year earlier, when policymakers were weighing weaker forecasts for employment and output against a temporary rise in inflation. She says GDP growth in 2025 comes in at 2.0 percent and Federal Open Market Committee participants now forecast 2026 growth of 2.2 percent, both above last year's projections, while labor productivity has grown about 2.5 percent a year over the past two years.

She says inflation is near its highest level since 2023 and remains well above the Fed's 2 percent target, with the price index the central bank targets rising 3.7 percent in the 12 months through June. Core goods prices are increasing at a 5 percent annual pace so far this year, which she says shows the recent acceleration is not only an energy story.

AI spending and supply shocks keep pressure on rates debate

Cook says the economy has faced two unexpected price shocks this year, the Middle East conflict and increased capital expenditure linked to AI infrastructure. She says higher energy prices are likely to spill over into other goods such as food, while spending on chips, high-tech equipment, software and utilities is adding further inflation pressure.

She notes that she voted with the rest of the FOMC last month to keep rates steady, arguing that tariff-related pressures and the Middle East conflict should in theory have only short-lived effects. Still, she says the risks remain strongly tilted toward higher inflation, partly because companies have announced more than $1.5 trillion in data center plans and only a small share has been realized, pointing to more investment demand ahead.

Cook says longer-lasting inflation is a risk if firms and workers base pricing and wage decisions on the recent period of elevated inflation rather than the original source of the shocks. While she says medium- and long-run inflation expectations remain mostly anchored and wage measures continue to decelerate, she adds that if disinflation does not appear soon, she is prepared to act.

Our earlier report on the Senate Banking Committee hearing on Fed priorities described lawmakers pressing the central bank to keep its focus on price stability, employment, and affordability as policy decisions feed through to household borrowing costs. It also outlined calls for reforms such as careful balance-sheet reduction and a more cautious approach to regulation, while warning against expanding the Fed’s mandate into areas like artificial intelligence.

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