The July consumer price index rose 8.5% from a year ago. That's less than the 8.7% expected and well off June's 9.1% level. Still, there is still a chance core inflation could ratchet up, an economist says.

Core CPI rose 5.9% annually in July, and 0.3% monthly, compared with estimates of 6.1%. "It's a welcome first step, but I don't think it's much more than that," said Pugliese. August CPI is released Sept. 13, and the Fed's policy board next meets Sept. 20-21.

Treasury yields fell as traders bet the Fed might be less likely to proceed with another three-quarter point rate hike next month. The Fed raised rates by 0.75 of a percentage point in both June and July. Many economists expect the Fed to begin to ease up its rate hiking after the next meeting.

The market and the Fed are now waiting for more data that could help determine whether the Fed will raise interest rates by 50 basis points or 75 basis points in September. Prior to the CPI report, fed funds futures were pricing in odds of about 73% for a three-quarter point hike.

Headline inflation was affected by a decline in energy prices of 4.6%, and gasoline was down 7.7%. Food continued to rise, up 1.1% on the month. A strong labor market is one thing that could keep the Fed on course for a heftier hike.
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