New York Federal Reserve President John Williams said the Fed may need to raise interest rates once more this year, but current economic and inflation conditions do not justify additional hikes in 2027. He expects inflation to cool markedly next year and move close to the Fed's 2% target over the course of the year, even as investment in artificial-intelligence infrastructure keeps demand strong.
Energy, tariffs and AI lift near-term inflation
Williams said he had recently raised his inflation outlook because of three main factors: the impact of tariffs, the Middle East conflict and energy prices, and stronger demand generated by investment in AI infrastructure.
The effect of tariffs on imported goods has broadly followed the path anticipated by earlier models and analysis. The impact has been concentrated in imported products and has not yet spread materially to other prices across the economy. Williams said most of the tariff effect has likely already occurred, although tariffs have provided a meaningful boost to core inflation over the past year to 18 months.
Energy prices have become a more important factor in the near-term inflation outlook. Oil prices remain elevated after rising, feeding through to consumer prices via fuel, air travel and food. Airfares offer a visible example, but energy is also a key input for a wide range of goods and services, so the effect is not limited to transportation.
AI investment is a newer source of pressure. Rapid growth in data-center construction and chip demand has pushed up the cost of some AI-related goods and inputs, with consumer products that use semiconductors also affected. Williams has also observed some spillover into construction labor costs, suggesting that AI-related demand could influence inflation beyond the prices of goods alone.
Underlying inflation measures continue to ease
Although these factors have left inflation higher this year than previously expected, Williams said inflation expectations remain stable, wage growth is relatively moderate, and unit labor-cost growth is broadly consistent with inflation at or below 2%.
He noted that the New York Fed's multivariate trend inflation measure is currently around 2.3%. The Dallas Fed's trimmed-mean inflation measure has also been at roughly the same level over the past six months. Neither measure is perfect, Williams said, but both indicate that underlying inflation has not begun accelerating persistently because of energy and AI-related pressures. Some measures are still moving lower.
Williams expects the effect of tariffs to largely drop out of year-over-year comparisons next year. Energy prices are also unlikely to keep pushing inflation higher and could instead help bring it down. Provided that supply and demand remain broadly balanced, he said overall inflation should continue to ease.
September hike reflected a reassessment of risks
Williams said he firmly supported the Federal Reserve's decision to raise rates in September. In his view, the incoming data made the move more appropriate, particularly as energy prices could remain elevated for longer and the scale and durability of AI-driven demand had become clearer.
Markets had previously expected oil prices to retreat relatively quickly and placed considerable weight on the possibility of an easing in tensions in the Middle East. Energy prices, however, have remained high. The pass-through from crude oil to gasoline and diesel prices has also been more pronounced, while disruption to refining capacity linked to the Middle East and the conflict between Russia and Ukraine have added to fuel-cost pressures.
Williams said AI investment could continue supporting demand for some time, while supply would need time to catch up. In that environment, a measured adjustment to monetary policy could help contain inflation without placing an unsustainable burden on an economy that remains resilient.
He described the rate increase as a risk-management decision rather than a fundamental change in the economic outlook. Downside risks to the maximum-employment goal had diminished, while the economy had remained resilient and had even strengthened somewhat at the margin. At the same time, energy prices and AI demand had modestly increased upside inflation risks. The rate hike therefore reflected a reassessment of the balance of risks, not a wholesale change in the direction of the economy.
CPI will be assessed for underlying trends
The next US consumer price index report will be released before the Federal Reserve's next policy meeting. Williams said officials would examine seasonal patterns and unusual factors closely, but would not set policy based on a single month's data.
He is paying greater attention to services, housing and goods prices excluding energy and certain AI-related items. The key question is whether underlying inflation continues to move toward the 2% target. Williams did not identify a specific core CPI reading that would concern him. He said a lower reading would be preferable to a higher one, but that the more important issue was whether the adjusted inflation trend remained on the right track.
Williams also stressed that monetary policy typically takes one to two years to pass fully through the economy. A single monthly report therefore cannot determine the policy path; officials must assess what current information implies for economic activity and inflation over the coming year.
AI demand is strong, but the economy is broader than AI
Williams said relatively small changes in interest rates were unlikely to alter the AI sector's long-term investment trend. Investors broadly expect AI to raise productivity and reshape the economy, which may make the sector less sensitive to interest rates than housing, non-AI business investment and other borrowing-dependent activity.
The US economy, however, is worth more than $30 trillion, and AI represents only one part of it. Interest rates and financial conditions continue to affect broader activity through housing, other business investment, longer-term yields and the dollar. The current situation is unusual because one large segment of the economy is still expanding rapidly while other sectors remain sensitive to tighter financial conditions.
Chip prices may not fall in the near term and could continue to rise. Williams is therefore focused not on the price of any single product, but on whether AI-related costs begin to build alongside pressures from labor, imported goods and other inputs.
The US unemployment rate is currently just above 4% and remains relatively stable. Williams said the labor market has some spare capacity but is not out of balance. Measures such as wages and hourly earnings also do not point to broad-based cost pressures. Based on the available data, he said there was still no widespread force pushing up business costs beyond energy prices and AI-driven demand.