The mixed inflation report from the Labor Department on Wednesday followed data last week showing the labor market still cooling in an orderly fashion in August, with the unemployment rate retreating from near a three-year high touched in July.

Financial markets boosted the chances of a quarter-point rate cut next Wednesday on the inflation data and sharply lowered the probabilities of a 50 basis points reduction.

"The road to normal inflation hit a bump in August as lingering pressures for housing and service costs once again cropped up," said Ben Ayers, senior economist at Nationwide. "This should clinch a smaller, 25 basis points rate cut from the Fed next week as Fed officials remain wary to feed any lingering price momentum for the economy."

The consumer price index increased 0.2% last month after rising by a similar margin in July, the Labor Department's Bureau of Labor Statistics said.

Food prices edged up 0.1% after climbing 0.2% in each of the past two months. Grocery food prices were unchanged as increases in the costs of meats, fish, eggs and dairy products were offset by decreases in the prices of nonalcoholic beverages, fruits and vegetables.

The cost of energy products dropped 0.8% after being unchanged in July. Gasoline prices fell 0.6%, while electricity was 0.7% cheaper and natural gas prices declined 1.9%.

In the 12 months through August, the CPI advanced 2.5%. That was the smallest year-on-year rise since February 2021 and followed a 2.9% increase in July.

Economists polled by Reuters had forecast the CPI gaining 0.2% and rising 2.6% year-on-year. Though inflation remains above the U.S. central bank's 2% target, it has slowed considerably, allowing policymakers to focus more on the labor market in their quest to sustain the economic expansion.

Government data last week showed nonfarm payrolls increasing below expectations in August but the unemployment rate falling to 4.2% from near a three-year high of 4.3% in July. The labor is cooling amid a significant moderation in hiring, reducing the risks of inflation reigniting.

HIGHER RENTS

Financial markets saw a roughly 15% probability of a 50 basis points rate cut at the Fed's Sept. 17-18 policy meeting, down from 29% before the CPI data was published, according to CME Group's FedWatch Tool. The odds of a quarter-point rate reduction were around 85%, up from 71% earlier.

The central bank has maintained its benchmark overnight interest rate in the current 5.25%-5.50% range for a year, having raised it by 525 basis points in 2022 and 2023.

The dollar rose against a basket of currencies. U.S. Treasury prices fell.

Annual consumer price growth has slowed considerably from a peak of 9.1% in June 2022 as higher borrowing costs curb demand.

Excluding the volatile food and energy components, the CPI climbed 0.3% in August after rising 0.2% in July. The so-called core CPI, seen as a measure of underlying inflation was boosted by a rise of 0.5% in shelter, which include rents and hotel and motel accommodation.

Owners' equivalent rent, a measure of the amount homeowners would pay to rent or would earn from renting their property, rose 0.5% after advancing 0.4% in July. The cost of hotel and motel rooms surged 1.8% after rising 0.2%.

Shelter costs offset a 1.0% decline in used cars and trucks prices as well moderate declines in the costs of household furnishings and operations, healthcare, communication, recreation and personal care.

In the 12 months through August, the so-called core CPI increased 3.2%. That followed a 3.2% gain in July.

(This story has been refiled to fix a typo in paragraph 3)