Inflation stayed at 3.7% in July on a 12-month basis, driven higher by rising energy and goods prices, according to a September 3, 2026 economic outlook published by the Federal Reserve Bank of San Francisco. Research advisor Huiyu Li shared the Economic Research Department's analysis, which found that the U.S. economy keeps expanding at a steady clip, supported by stronger labor productivity growth. Financial markets now anticipate the Federal Open Market Committee will lift the federal funds rate to roughly 4.25% by mid-2027, equivalent to two or three quarter-point increases.

Real GDP expanded at a 1.5% annualized pace in the second quarter and grew 2.1% over the past four quarters, matching the Fed's 2% trend growth estimate. Core PCE inflation, which strips out volatile food and energy categories, also held at 3.3% in July. Energy, food, and goods together accounted for about 1.2 percentage points of headline inflation in July, compared to an average of zero percentage points during the 2016 to 2019 pre-pandemic period. Supercore inflation—core services excluding housing—remains elevated at 2.0 percentage points versus 1.1 percentage points before the pandemic. The unemployment rate stood at 4.1% in July, holding in a narrow band around that level since late 2024, but total payroll growth averaged just 44,300 jobs monthly over the six months ending in July, with the economy shedding about 23,000 jobs in July and adding only 20,000 in June.

At its July meeting, the FOMC held the target range for the federal funds rate at 3.50% to 3.75%, unchanged since December 2025. During his August 28 remarks at the Jackson Hole Economic Policy Symposium, FOMC Chairman Kevin Warsh reiterated the Committee's commitment to achieving both sides of the dual mandate, noting that "inflation has been above the FOMC's 2% goal for 65 straight months." The report's forecast projects headline and core inflation peaked this year and will gradually decline toward the 2% goal, though uncertainty around the baseline forecast remains high and risks appear tilted to the upside. The stability of the unemployment rate amid declining job growth over the past two years indicates worker demand and supply have slowed together, posing a risk that unemployment could rise if firms' demand for workers is negatively impacted by rising input costs.

Strong labor productivity growth has powered above-trend output expansion since 2023, with business sector output per hour growing at an average annualized rate of 2.5% from the first quarter of 2023 to the second quarter of 2026—significantly faster than the 1.5% rate recorded from 2005 to 2022. But two factors account for much of the recent strength: increases in capital investment and utilization have contributed 1.3 percentage points to labor productivity growth since early 2023, nearly double the contribution observed over the 2005 to 2022 period. Total factor productivity growth, which reflects the contribution of better technology after subtracting other factors, was 0.7% since 2023—somewhat higher than the 0.5% pace from 2005 to 2022 but much smaller than the 2% pace during the strong productivity growth period of 1996 to 2004. Industries experiencing faster AI adoption don't contribute more to overall productivity growth than they did before the pandemic, the report found. Whether stronger productivity growth linked to advances in AI technology could help the economy expand above the 2% trend remains to be seen, leaving open the key question of whether recent productivity gains reflect lasting benefits from investment in artificial intelligence or just a temporary boost from capital investment and factor utilization.