Fed report cites 'stepped-up' inflation due to tariffs, Iran war, AI buildout

US inflation "stepped up further this spring" as the evolving impact of tariffs, a war-related rise in energy costs, and the booming artificial intelligence buildout boosted price pressures that took root last year, the Federal Reserve said on Friday in a monetary policy report to Congress.

"Inflation has risen this year and remains elevated relative to the Federal Open Market Committee's longer-run objective of 2%," with the most recent data showing the US central bank's preferred Personal Consumption Expenditures Price Index running about double that rate as of May, the report said.

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By contrast, "the labor market has stabilized, with demand and supply roughly in balance," and the June unemployment rate of 4.2 percent still "low," the Fed report said while noting the shifting demographic and hiring trends that are helping keep it that way.

Job vacancies have been "flat," the report noted, layoffs have been similarly "subdued," and the labor force itself — the pool of people available to work and contribute to economic output — has stagnated.

"A marked slowdown in immigration and ongoing declines in labor force participation due to the aging of the population led to a slowdown in labor supply growth," the document said.

On the whole, though, the report concluded that the economy's potential was "rising at a solid pace as historically subdued growth in the labor force has been offset by strong growth in labor productivity."

Overall economic growth was "moderate" through the first months of 2026, with gross domestic product expanding at a 2.1 percent annual pace, supported by booming AI investment but held back by a "stagnant" housing market and only modest gains in household consumption.

The report to Congress is the first issued under new Fed Chairman Kevin Warsh, who is set to appear before committees in the US House of Representatives and Senate next Tuesday and Wednesday, respectively, in what are supposed to be twice-a-year congressional reviews of monetary policy.

The usual spring hearing was delayed amid controversy between former Fed Chair Jerome Powell and President Donald Trump, with Warsh taking over in late May after Powell's term as head of the central bank ended.

US stocks closed higher on Friday, with the Dow gaining nearly three-tenths of a percent, the S&P 500 adding more than four-tenths of a percent.

The Fed has held interest rates steady since December, but concerns about inflation, particularly since the start of the US-Israeli war with Iran in late February, have led investors to anticipate rate increases later this year.

While Warsh does not like to talk about expected policy outcomes, his colleagues at the June 16-17 meeting issued projections showing an even divide among those anticipating rate increases this year, and those expecting the policy rate could stay steady or fall.

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The mention of AI as an inflation driver, at least in the near term, is notable.

Warsh has looked to the technology as a source of lower inflation, given its likely boost to productivity, but has lately acknowledged the timing of those productivity and supply-side gains is uncertain while the demand for electricity, specialized chips and other materials involved in the buildout is continuing.

The report pointed to other themes Warsh has emphasized, including the first mention of the size of the money supply since 2016.

Growth in the money supply has in recent decades been downplayed as a driver of inflation, but the experience of the COVID-19 pandemic, when large government transfer payments to households supercharged demand at a time of global supply constraints, has prompted a rethink.

During his Senate confirmation hearing in April, Warsh said he felt inflation "comes about when the government prints too much ... spends too much."

In a section on "M2" — a measure of circulating money made up of cash, and cash-like deposits including retail money market funds — the report noted that annual growth had returned to levels "typically observed in the 2010s."

It said "the sizable increase in the public's holdings of real money balances that took place during the pandemic has largely been unwound" — a possible reason to think inflation will be restrained.

The Fed through the 2010s struggled with inflation that was persistently below its target.

In a section on monetary policy rules, which Warsh has referred to as "aspirational," the report noted that a variety of policy prescriptions currently point to the need for rate hikes — but then cautioned against taking that advice to heart.

"The prescriptions shown here ignore that the economy would have evolved differently if the policy rate had followed one of the paths prescribed by the rules, and, hence, these prescriptions should be interpreted with care," the report stated.