Markets are bracing for key inflation data next week. Analysts say expect a 'knee-jerk' gain if CPI falls, but don't bet on the Fed to pivot at its upcoming meeting.

• Cooling inflation in August could stoke hopes the Fed will downsize its next rate hike.
• Headline inflation may ease to a still-hot reading of 8.1%, and stocks could rally if it comes in under that.

The upcoming US inflation report is expected to show further signs of cooling in consumer prices, data that may provide a short-term bump higher for a stock market that's still vulnerable to downside pressure, market experts say.

This week, some investment banks upwardly revised their rate-hike forecasts for the Federal Open Market Committee's meetings in September and November. Among them, Bank of America now expects an increase in the Fed Funds rate of 75 basis points in September and a move of 50 basis points in November, compared with its previous expectations of 50 and 25 basis points, respectively. It also added a forecast of a January rate hike of 25 basis points.

"Although we move to a 75bp rate hike in September, we acknowledge there are risks to a smaller 50bp hike," BofA said in a note published Thursday. In one risk, "next week's Consumer Price Index report may surprise to the downside, opening the door to a smaller hike," it said.

The Labor Department's August inflation report is due Tuesday with a consensus call among economists putting headline inflation at 8.1%. That rate would mark a decline from 8.5% in July and June's 9.1% print which was the highest in 41 years.

"The knee-jerk reaction would be very positive for stocks," Edward Moya, senior market analyst at Oanda, told Insider. "You're going to see a lot of investors anticipate that the Fed's job of raising rates might be done a lot sooner."

Investors have been pricing in expectations the Fed this month will deliver a third consecutive rate increase of 75 basis points to help bring inflation down toward its 2% target. The Fed has raised rates four times this year to a range of 2.25%-2.5%.

A drop in gasoline prices helped soften July inflation and gas prices have since continued to move lower. The average US price of gas was $3.78 a gallon as of Friday, according to motor club AAA, down from $4.03 a month ago.

While lower gas prices help, Moya said ongoing supply-chain snags and elevated shelter and electricity costs could prove stubborn for the Fed.

"I think we're going to see that a lot of this inflation is sticky. Some of this inflation's going to fight back. The Fed's job is not going to be complete by the end of the year and the market is going to have trouble grappling with that. And risk appetite is going to struggle over the next few months," said Moya.

A decline in used car prices may contribute to an overall drop in the reading of consumer prices in August, Wayne Wicker, chief investment officer at MissionSquare Retirement, told Insider.

"On a month-over-month basis, we're gonna start to see negative numbers coming through and with that, inflation expectations ought to be coming down pretty dramatically. But I think there'll be a disconnect between the actual data coming through and policy," he said.

"Powell is still pretty adamant that until inflation gets down closer to that two, two and a half percent range, they're going to be pretty vigilant," Wicker said. "While I think there will be some short-term relief on equity markets should we see this increased deceleration in inflation, we'll have bouts of concerns again with tightening by the Fed. We're not out of the woods and this isn't going to stop anytime soon."

Wicker said he expects the Fed to raise the Fed Funds rate by three-quarters of a percentage point at the September 20-21 meeting.

Goldman Sachs and Barclays also raised their rate-hike forecasts to 75 basis points for September and 50 basis points for November. Barclays said it now only sees an "outside chance" that softer-than-expected August inflation figures will swing the pendulum back toward an increase of 50 basis points at the September FOMC meeting.

The probability of a September hike of 75 basis points climbed to 86% on Friday from 57% a week earlier, according to the CME FedWatch tool.