Fed Holds Rates Steady, but Two Officials Back a Cut

The outcome of hand-to-hand combat over who will bear the burden of tariffs figures to shape the trajectory for inflation and hiring later this year, which could resolve whether and when the central bank resumes rate cuts in the months ahead.

Powell said the Fed was committed to making sure any one-time increases in prices didn’t lead to more-persistent inflation. “We want to do that efficiently, though—efficiently,” Powell said. “If you move too soon, you wind up maybe not getting inflation all the way fixed and you have to come back [and raise rates]. That’s inefficient. If you move too late, you might do unnecessary damage to the labor market.”

Dissents from two Fed governors and Trump appointees, Michelle Bowman and Christopher Waller, offered limited insight into the Fed’s coming moves. Both favored reducing rates by a quarter-point on Wednesday. Bowman’s dissent marked a notable shift for someone who had been a leading advocate for tighter policy in recent years and who in September supported a smaller rate reduction than her colleagues wanted.

Waller had signaled two weeks ago his support for lowering rates, which coincides with his nascent candidacy to succeed Powell as chair next spring. He said earlier this month he was concerned about keeping rates too high for an economy that lacks the momentum to drive inflation higher—a view shared by some economists and former Fed officials.

The Fed’s 12-person rate-setting committee includes all seven governors on the central bank’s board, who are appointed by the U.S. president. The other five voters are drawn from among 12 regional-bank presidents, many of whom vote on a rotating basis.

It was the first meeting since 2020 in which more than one Fed official voted against Powell, and the first since 1993 in which more than one board governor dissented.

Ahead of Wednesday’s decision, Trump said he thought the Fed would cut rates in September.

Powell deflected such speculation, leaving the Fed’s options wide open. He made no effort to tee up a September cut, even though he also wouldn’t rule it out. Expectations of a rate cut declined modestly on Wednesday. After the meeting, investors in interest-rate futures markets saw a roughly 45% chance of a September cut.

Powell and his colleagues are studying how tariffs filter through inflation data in the midst of anxiety that higher goods prices will keep inflation above the Fed’s 2% goal for a fifth year. Inflation has declined notably from 2021-23 highs without the recession many economists had predicted, but officials are cautious about declaring victory and possibly reigniting price pressures by cutting rates prematurely.

Companies stockpiled inventory before tariffs took effect and have been reluctant to raise prices given the possible loss of market share from inflation-fatigued consumers. But some economists warn that as businesses with thinner margins deplete their pretariff stock and face higher costs due to tariff increases, they will increasingly be forced to pass these expenses on to consumers.

“We learned that the process will probably be slower than expected at the beginning, but we never expected it to be fast, and we think we have a long way to go to really understand exactly how it will be,” said Powell, who goes by Jay.

Inflation readings in June have indicated modest price pressures because services prices have been better behaved.

“Jay is navigating so many things right now, but one thing that he says that is both true and underappreciated by his critics is that the tariffs are showing up in certain parts of the price index,” said Richard Clarida, a Trump appointee who served as Powell’s second in command for more than three years beginning in 2018.

Economic data released earlier Wednesday offered mixed signals, explaining the Fed’s caution. While second-quarter GDP growth topped expectations at 3%, a measure of private business and consumer demand continued decelerating to 1.2% from 1.9% in the previous quarter and 2.9% late last year.

The Fed finds itself in a two-steps-forward, one-step-back cycle when it comes to gaining clarity on the Trump administration’s economic policies. Recent trade deals with Japan and the European Union established tariffs at 15% without retaliation—below President Trump’s April threats, but higher than early-year forecasts.

Trump’s unpredictable approach leaves room for future tariff escalations at the same time that a court challenge could nullify them.

On the fiscal front, Trump signed a major tax cut package this month. Some Republican lawmakers are discussing consumer rebates that could add stimulus to an economy the central bank views as near full capacity—raising the odds Fed officials would regret cutting rates if the labor market remains steady.

Meanwhile, Trump and his advisers have acted as a battering ram against the central bank, turning portions of the public against the Fed in an effort to secure lower rates. The Fed cut rates by 1 percentage point between September and December last year.

Advisers including Treasury Secretary Scott Bessent have said the Fed is being inconsistent in how it approaches rate decisions. “Based on the way they cut rates last fall, they should be cutting rates now,” he said last week at a meeting in the Oval Office with Trump.

The July meeting represented an initial fracturing of a Fed consensus to hold steady that emerged six months ago. The question that could further divide policymakers in the coming months is whether tariffs will damage the economy faster than they fuel inflation, and whether waiting for answers risks misjudging any course correction on either front.

The September decision could prove straightforward if the data breaks decisively in either direction. Sticky inflation readings alongside solid growth would make it easier to defer rate cuts, while clear economic deterioration would justify cutting. But if the current muddle persists, Powell faces more agonizing decisions.

Data that continues to unfold along the recent pattern “could make it very tough—if it’s not bad enough to make it a slam dunk to cut, and it is not good enough to declare victory,” said Clarida. As a result, “It is more plausible than some folks think that Jay could just sit on his hands” and leave rates where they are at each of the policy meetings remaining in his term.

Write to Nick Timiraos at Nick.Timiraos@wsj.com

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