The Federal Reserve is gearing up for its policy meeting next week, but before making any decisions, it is closely examining inflation readings to determine the extent of the widely anticipated interest rate cuts. With the recent jobs report failing to provide clarity on the matter, the focus now shifts to the consumer and producer price index reports.

This week, the Labor Department's Bureau of Labor Statistics will release its consumer price index report for August, followed by the producer price index report, also for August. These reports will serve as crucial indicators of cost and inflation at both the consumer and wholesale levels.

The consensus forecast suggests a 0.2% increase in the consumer price index for both the all-items measure and the core, which excludes volatile food and energy items. On an annual basis, this translates to respective inflation rates of 2.6% and 3.2%. Similarly, the producer price index is projected to rise by 0.2% on both headline and core figures. The Federal Reserve generally places more emphasis on the core index as a better indicator of longer-term trends.

While these inflation readings may not align closely with the Fed's 2% long-run target, there are several important considerations to keep in mind. Firstly, the Fed primarily relies on the Commerce Department's personal consumption expenditures price index as its principal yardstick for inflation. Additionally, policymakers are concerned not only with the absolute value of inflation but also with its direction of movement. In recent months, there has been a notable moderation in inflation, particularly in headline prices.

Despite ongoing attention to inflation, the focus for Fed officials has shifted towards concerns about the state of the labor market. Hiring has significantly slowed since April, with a decline in average monthly gains in nonfarm payrolls. Consequently, the Fed is increasingly expected to implement rate cuts as a response.

Though market expectations currently suggest a gradual reduction in rates, with a quarter percentage point reduction being the most likely scenario, some economists argue for a more aggressive approach. Samuel Tombs, Pantheon Macroeconomics' chief U.S. economist, believes that the summer slowdown in hiring may intensify in the coming months. He anticipates strong justification for rapid rate cuts by the meeting in November, supported by further employment reports.

While the Fed eagerly awaits the latest inflation readings, it remains to be seen how the upcoming data will impact the decision-making process. As the potential for interest rate cuts looms, market projections indicate a reduction in September, followed by a half-point reduction in November and possibly another in December.

It is evident that inflation data, once a significant factor, has taken a backseat to concerns over the labor market. Ultimately, it will be the combination of these factors that will shape the Fed's decision on interest rates and their subsequent impact on the economy.