CPI Report Key for Interest Rate Watchers

Tuesday’s report on the U.S. consumer price index for July might hold the key to when Federal Reserve policymakers may next raise interest rates, and by how much. The CPI is expected to have risen 0.3% in July--mainly reflecting higher energy costs--after showing no change in May and June, analysts said. The core rate of inflation, excluding food and energy, probably rose just 0.2% last month. On Friday, a smaller-than-expected 0.2% increase in July’s producer price index calmed investors and sent government bond yields lower. Investors concluded the Fed will probably opt for a quarter-point increase in the overnight bank lending rate next week, instead of something larger.

The Fed’s policy-setting panel, the Federal Open Market Committee, holds its next session Aug. 24. At its last session, on June 30, the Fed raised the overnight rate by a quarter percentage point to 5%. The federal funds futures contract for September delivery, used by banks as a hedge against changes in the overnight bank rate, has an implied yield of 5.23%--suggesting most investors are counting on a quarter-point increase next week. The fed funds futures for January have an implied yield of 5.5%, a sign investors don’t think next week’s will be the last rate increase.

Other U.S. economic reports for release Tuesday will probably provide little comfort for the Fed, which is also worried that excessive growth and consumer demand might provide the tinder for inflation. Industrial production probably increased during July as manufacturing accelerated after spending much of the last year in the doldrums. Output at the nation’s factories, mines and utilities probably rose 0.8% last month, analysts said. In June, orders increased 0.2%.

Also Tuesday, the Commerce Department is expected to report that starts of new housing construction accelerated in July, rising 2.1% to 1.604 million at a seasonally adjusted annual rate from 1.571 million in June, analysts said.

Other reports coming this week:

* First-time claims for state unemployment benefits probably increased by 4,000 in the week ended Aug. 14 to a seasonally adjusted 288,000 after rising by 4,000 a week earlier. Still, the four-week moving average for jobless claims, already at a 10-year low, is near a quarter-century low. The Labor Department will issue the report Thursday.

* The international trade deficit in goods and services probably narrowed to $20.5 billion in June from $21.3 billion during May as exports staged a rebound, analysts said. The Commerce Department will release the trade report Thursday.

* The Federal Reserve Bank of Philadelphia, in a report set for release Thursday, is expected to report a pickup in manufacturing in August in eastern Pennsylvania, southern New Jersey and Delaware, analysts said.

* The U.S. government probably posted a narrower budget deficit in July than a year earlier, $23.4 billion versus $24.1 billion, as the Treasury closes in on its second consecutive annual surplus, analysts said. In June, the government reported a $53.6-billion surplus, reflecting the strong economy and bountiful tax revenue. The Treasury issues the report Friday.