Fed expected to hold rates steady in July, hike in September

By Ann Saphir

June 25 (Reuters) - The Federal Reserve won't raise interest rates next month even after a government report showed inflation based on the U.S. central bank's targeted measure was the highest it has been in three years, traders bet on Thursday, though they continue to see a rate hike in September as very much in play.

Financial markets are now pricing in only about a 30% chance of a rate hike at the central bank's July 28-29 meeting, versus nearly 40% earlier on Thursday, based on trading in CME Group's Fed funds futures contracts. They still see about an 80% chance that the Fed will raise its benchmark interest rate at the September 15-16 meeting, rather than keeping it in the current 3.50%-3.75% range.

The Personal Consumption Expenditures Price Index jumped 4.1% in the 12 months through May, the?largest increase since April 2023, the Commerce Department's Bureau of Economic Analysis said on Thursday.

The Fed targets 2% for the 12-month change in that index, a goal it hasn't hit for more than five years and which Fed Chairman Kevin Warsh at his first meeting earlier this month said that he and his fellow policymakers would deliver. Traders and analysts have widely taken that remark and others about the need to bring down inflation as boosting the chances of near-term rate hikes.

Excluding the volatile food and energy components, the so-called core PCE Price Index increased 3.4% on a year-over-year basis in May after rising 3.3% in April.

"May's PCE report is a reminder that the inflation fight is not over, but it is also not a clear sign that underlying price pressures are breaking higher again," Martin Beck, chief economist at Public Policy Holding Company (PPHC), wrote in a note, adding that the core PCE measure did not accelerate on a month-to-month basis.

With fuel prices that drove much of May's headline inflation jump now down sharply,?"the Fed can stay patient rather than panic," he wrote.

Oil prices are now down to near their pre-Iran war levels after a first round of high-level talks on a peace deal concluded on Monday in Switzerland.

(Reporting by Ann Saphir; Additional reporting by Lucia Mutikani; Editing by Alexandra Hudson and Paul Simao)