U.S. Inflation Accelerates as Tariffs, Energy Costs and AI Spending Rise
U.S. inflation increased further during the spring as tariffs, higher energy prices linked to the Iran war, and rapid investment in artificial intelligence added to existing price pressures.
The Federal Reserve outlined these concerns in its latest monetary policy report to Congress.
According to the report, inflation has risen in 2026 and remains well above the Federal Open Market Committee’s long-term target of 2%.
The Fed’s preferred inflation measure, the Personal Consumption Expenditures Price Index, was running at roughly twice that target in May.
U.S. Labor Market Remains Stable
While inflation has strengthened, the U.S. labor market has remained relatively balanced.
The Fed said that labor demand and labor supply were broadly aligned. It also described the June unemployment rate of 4.2% as low.
Job vacancies have changed little, while layoffs have remained limited.
However, the size of the labor force has stagnated. This means the number of people available to work and contribute to economic output has shown little growth.
Slower Immigration Restrains Labor Supply
The Fed linked weaker labor supply growth to lower immigration and an aging population.
A sharp slowdown in immigration has reduced the number of new workers entering the economy.
At the same time, labor force participation has continued to decline as a growing share of the population reaches retirement age.
Despite these challenges, the Fed said the economy’s productive capacity was still expanding at a solid pace.
Strong productivity growth has helped offset historically weak growth in the workforce.
U.S. Economic Growth Remains Moderate
The U.S. economy expanded at a moderate rate during the first months of 2026.
Gross domestic product grew at an annualized pace of 2.1%, supported by strong investment in artificial intelligence infrastructure.
However, economic growth was limited by a stagnant housing market and only modest increases in household spending.
The report suggests that AI investment is becoming an increasingly important source of economic activity, even as other parts of the economy remain weak.
Kevin Warsh Prepares for Congressional Testimony
The report is the first released under new Federal Reserve Chairman Kevin Warsh.
Warsh is scheduled to appear before committees in the House of Representatives and the Senate next Tuesday and Wednesday.
These hearings form part of the Fed’s twice-yearly review of monetary policy before Congress.
The usual spring hearing was delayed amid tensions involving former Fed Chair Jerome Powell and President Donald Trump.
Warsh took over in late May after Powell’s term as head of the central bank ended.
Investors Expect Possible Interest Rate Hikes
The Federal Reserve has kept interest rates unchanged since December.
However, renewed inflation concerns have led investors to expect that the central bank could raise rates later in 2026.
Those concerns have intensified since the beginning of the U.S.-Israeli war with Iran in late February.
Warsh has avoided making clear predictions about future policy decisions.
Nevertheless, projections from the Fed’s June 16–17 meeting showed policymakers were evenly divided.
Some officials expected interest-rate increases, while others believed rates could remain unchanged or move lower.
AI Investment Creates Mixed Inflation Effects
The report’s treatment of artificial intelligence as an inflation driver was particularly notable.
Warsh has previously argued that AI could reduce inflation over time by improving productivity.
However, he has also acknowledged that the timing of those benefits remains uncertain.
In the short term, the AI buildout is increasing demand for electricity, advanced semiconductors, data centres and specialised materials.
That surge in investment could add to inflation before the technology delivers broader productivity gains.
Fed Report Revisits Money Supply Growth
The report also returned to the subject of money supply for the first time since 2016.
Money supply growth has received less attention in recent decades as a direct cause of inflation.
However, the experience of the COVID-19 pandemic has renewed interest in the relationship between government spending, money growth and rising prices.
Large transfer payments to households boosted demand during the pandemic, while global supply chains remained under pressure.
During his Senate confirmation hearing in April, Warsh argued that inflation can result when governments create and spend too much money.
M2 Growth Returns to Earlier Trends
The report included a section on M2, a broad measure of money circulating in the economy.
M2 includes cash, bank deposits and retail money market funds.
Annual M2 growth has returned to levels commonly seen during the 2010s, according to the Fed.
The report also noted that the large increase in inflation-adjusted money balances during the pandemic has largely disappeared.
This could help limit future inflationary pressure.
During much of the 2010s, the Federal Reserve struggled with inflation that remained below its 2% target.
Policy Rules Point Toward Higher Rates
The report also examined several monetary policy rules.
These frameworks currently suggest that higher interest rates may be appropriate.
However, the Fed warned against relying too heavily on those models.
Such rules do not account for how the economy would have developed if interest rates had followed a different path.
As a result, the report said these policy recommendations should be interpreted carefully.
