Williams says inflation has peaked as core rate holds at 3.4%

New York Fed President John Williams said inflation has likely peaked, opening the door for the central bank to eventually ease policy as the core rate remains more than a percentage point above the Fed's 2% target.

"There are encouraging reasons to believe inflation has peaked," Williams, who holds a permanent vote on the Federal Open Market Committee, said July 15. He cautioned that the full economic impact of artificial intelligence remains difficult to predict and that the Middle East conflict continues to pose a risk to the outlook.

The Fed's preferred measure of core inflation stood at 3.4% in May, well above the central bank's 2% objective, where it has remained for more than five years. The fed funds rate has been held at 5.25% to 5.5% since July 2023, following the most aggressive tightening cycle in four decades. OIS markets price roughly a 45% probability of a rate cut by December, according to CME FedWatch data.

If Williams' assessment proves correct and price pressures continue to moderate, the central bank could begin unwinding its restrictive stance later this year, providing relief to mortgage borrowers and corporate issuers. The next FOMC meeting is scheduled for July 28-29.

Williams' comments come as the Fed navigates an inflation environment shaped by competing forces. The buildout of AI data centers — expected to top $700 billion in investment this year from Alphabet, Amazon, Meta and Microsoft alone — has pushed up memory chip costs by as much as 400% between 2024 and the end of this year, according to JPMorgan Chase economists. Apple raised laptop and iPad prices by 15% to 25% last month, while Microsoft announced a $100 increase for its Xbox console, both citing higher component costs.

Electricity prices have also accelerated, rising 5.9% in May from a year earlier, outpacing the 4.2% overall inflation rate. Goldman Sachs economists forecast electricity prices will rise 6% this year and next, with above-average increases persisting into 2028 as data center demand strains grid capacity.

A Series of Supply Shocks

The AI-driven price pressures follow earlier waves of inflation from tariffs imposed during the Trump administration and the gas price spike from the Iran conflict. The Fed typically looks through temporary price increases, but an ongoing series of such shocks threatens to entrench above-target inflation, according to Abiel Reinhart, an economist at JPMorgan. "In isolation one or two such shocks is perhaps transitory," Reinhart said. "A sustained series of shocks, or a wider range of shocks, becomes more concerning to them."

The Fed's Policy Crossroads

Fed Chair Kevin Warsh, who took office May 22, has argued that over time AI will make the U.S. economy more efficient, reducing inflation even as growth accelerates. He acknowledged July 1 that AI investment is currently boosting demand but declined to speculate on the magnitude of its inflationary impact.

Minutes of the June 16-17 FOMC meeting showed many policymakers worry that demand for AI-related equipment will continue to outstrip supply, creating persistent price increases. Williams himself noted that if AI creates "a sustained impulse to demand relative to supply," the central bank would need to respond rather than look through it.

The last time a senior Fed official signaled a peak in inflation was in late 2023, when then-Chair Jerome Powell suggested the tightening cycle was nearing its end. The S&P 500 rallied 24% over the following six months as rate-cut expectations built, before inflation reaccelerated in early 2025.

This article is for informational purposes only and does not constitute investment advice.