By Ann Saphir

(Reuters) – Federal Reserve policymakers on Friday received fresh confirmation that inflation is continuing to ease, paving the way for a potential interest rate reduction next month as they shift focus to preventing further cooling in the labor market.

The personal consumption expenditures (PCE) price index rose 2.5% in July year-over-year, matching the gain from June. Over the latest three months, the annualized reading on the Fed’s preferred gauge of inflation is well below its 2% goal.

Fed Chair Jerome Powell stated last week that “the time has come” to cut rates, following a campaign against decades-high inflation which resulted in aggressive rate hikes in 2022 and 2023. The central bank has maintained its policy rate in the 5.25%-5.50% range since last July.

Ben Ayers, a senior economist at Nationwide, noted, “The recent price trends confirm that the end of the Fed’s inflation fight is coming into view,” suggesting a likely rate cut at the Sept. 17-18 policy meeting. He added that continued cooling of inflation could allow the Fed to be more aggressive with rate cuts in subsequent meetings, especially if the labor market deteriorates significantly.

Following the report’s release—showing solid consumer spending—traders remained confident that the Fed would implement a quarter-percentage-point reduction initially but may opt for a larger half-percentage-point cut at a later meeting.

Financial markets continue to anticipate a total of a one-percentage-point cut by year-end. While many analysts predict slightly less due to the economy’s strength, they stress that upcoming labor market data will influence how aggressive the Fed may be.

Evercore ISI economists described the shift: the U.S. central bank has gone “from being an inflation-first Fed to a labor-first Fed.”

The unemployment rate has increased nearly a full percentage point to 4.3% since the Fed ceased rate hikes a bit over a year ago. While still low historically, this rise is significant enough for Powell to state that the Fed would be wary of any further weakening.

Attention now shifts to key upcoming data before the September meeting, including the U.S. government’s employment report for August and the consumer price index report for August next week.