Fed flags AI inflation risk as rate hike odds climb above 59%

The Federal Reserve has warned that strong artificial intelligence-related demand could keep inflation elevated, while market pricing for a U.S. interest rate hike this year has climbed above 59%.

According to the minutes of the Federal Reserve’s June Federal Open Market Committee meeting, policymakers discussed several paths for monetary policy depending on how inflation and the labor market develop.

One of the scenarios considered involved inflation staying above the central bank’s 2% target despite a stable labor market, driven by strong AI-related demand, the conflict in the Middle East, or the effects of tariffs.

Under those conditions, the minutes showed that almost all participants believed additional policy tightening would likely be needed to bring inflation back to the Fed’s target. At the same time, the document outlined an alternative scenario in which inflationary pressures ease, allowing inflation to move back toward 2%.

Elevated inflation keeps tightening on the table

In the event inflation begins to cool, almost all participants said maintaining the current federal funds rate or eventually lowering it would likely be appropriate, according to the meeting minutes.

The June meeting ultimately ended with the Federal Reserve leaving interest rates unchanged, the first policy meeting chaired by Kevin Warsh since taking over as Fed chair.

The minutes also revealed differences among policymakers over where interest rates should finish the year. Many participants projected that the appropriate federal funds rate would be within or slightly below the current target range by year-end. Others, however, judged that rates should end the year above the current range, highlighting continued uncertainty over the inflation outlook.

Separately, a few participants argued there was already a case for raising rates because upside inflation risks remained elevated while downside risks to the labor market had eased somewhat. Even so, those officials still supported leaving the policy rate unchanged at the June meeting.

Markets continue pricing another rate increase

While policymakers debated multiple scenarios, prediction markets have increasingly leaned toward another rate hike before the end of the year. According to Polymarket data, traders currently assign a 59% probability that the Federal Reserve will raise interest rates in 2026.

Those odds have increased this week following renewed tensions between the United States and Iran after President Donald Trump threatened additional military strikes against Iran, adding another potential source of inflation risk alongside energy market uncertainty.

Meanwhile, expectations for the Fed’s next meeting remain more balanced. According to the CME FedWatch Tool, there is a 69.5% probability that policymakers will leave interest rates unchanged at the July FOMC meeting. Although that remains the most likely outcome, the probability has declined from around 80% over the past week.

Current CME FedWatch pricing also shows a 30.5% chance of a rate increase in July, indicating that investors have become less certain that the Fed will be able to keep borrowing costs unchanged if inflation risks continue to build.

Taken together, the June meeting minutes indicate that Federal Reserve officials continue to view incoming inflation data as the deciding factor for future policy. While many members still see room to hold or eventually lower rates if price pressures ease, persistent inflation driven by AI demand, geopolitical developments, or tariffs could still push the central bank toward another rate hike later this year.