Inflation may be creeping higher after all

New York(CNN Business) The Fed may have to change its tune on inflation and potential rate cuts after a key report on consumer prices came in higher than expected.

Federal Reserve chair Jerome Powell told the House Financial Services Committee Wednesday that "there is a risk that weak inflation will be even more persistent than we currently anticipate."

But in the June Consumer Price Index data report Thursday morning, the US government said overall prices rose 0.1% in June while so-called core prices, which exclude food and energy, were up 0.3%.

The jump in core prices was the biggest monthly gain since January 2018. Core inflation is now up 2.1% over the past 12 months.

The government noted prices increased for housing, used cars and trucks, clothing, home furnishings, medical care and auto insurance among other categories.

In other words, weak inflation may not be as "persistent" as the Fed — or Wall Street — thought.

Investors still expect a small rate cut from the Fed at its next meeting later this month — but the calls for a larger move have ebbed a bit following the latest CPI data. (The Fed typically cuts rates when the economy is weak and inflation isn't a threat.)

Traders are pricing in a nearly 80% chance of a quarter-point rate cut and about a 20% probability of a half-point cut, according to federal funds futures tracked by CME Group. On Wednesday, the odds were 70% for a quarter-point cut and 30% for a half-point cut.

Investors shrugged off the CPI report though. The Dow topped 27,000 for the first time Thursday and other major market indexes were also higher.

What's less certain than the expected rate cut later this month is how many more times the Fed will cut rates after that.

"Today's CPI number won't take a quarter-point cut off the table but it does create some doubt about what happens after this month," said Crit Thomas, global market strategist with Touchstone Investments. "Do we really get two more rate cuts this year?"

Thomas said if the year-over-year core inflation increases remain around 2%, the Fed may not want to lower rates any further this year. The likely July move would just be a sort of insurance rate cut to keep the economy humming along.

But that strategy could backfire, according to Lindsey Piegza, chief economist at Stifel.

"It's a little confusing as to why the Fed is capitulating to market pressures," Piegza told CNN Business. "It's dangerous for the Fed to back itself in a corner."

Powell was on Capitol Hill again Thursday appearing before the Senate Banking Committee. As he did before the House Financial Services Committee on Wednesday, Powell talked Thursday about some of the challenges facing the United States and global economy.

Worries about China's economy losing steam and the fiscal issues facing Europe, where long-term bond yields are now negative or at zero in Germany and France, will probably lead the Fed to keep cutting rates.

The US economy may be on solid footing currently but that could change if trade tensions between the United States and China, Europe, India and Japan intensify.

And lower bond yields in other countries make US rates look expensive by comparison. So the Fed may want to cut rates simply to make US bonds more attractive to investors. Lower rates would also make borrowing more affordable for consumers and businesses.

"Powell is not looking at just the US economy right now; he's looking at the international landscape and the trade outlook," said Robert Frick, corporate economist with the Navy Federal Credit Union. "Negative rates globally are scary for the US and the Fed needs to be ready to act if necessary. Psychologically that makes a difference."