PCE Inflation Report: Key Measure Edges Higher in July, Prompting Speculation on Fed Action

The latest inflation report, particularly a key measure closely monitored by the Federal Reserve, has shown a slight uptick in July. This development is stirring speculation about whether the Federal Reserve will opt for another interest rate hike this year.

The U.S. Department of Commerce reported that consumer prices rose by 3.3% compared to the previous year. This uptick, while surpassing the 3% pace seen in June, remains below the alarming 40-year high of 7% recorded in June 2022. However, it’s important to note that much of the July increase is attributed to the fact that inflation had already started to ease somewhat by July 2022. Consequently, the price gap between July 2022 and July 2023 appeared more substantial.

On a month-to-month basis, prices increased by 0.2%, in line with the prior month’s figures. It’s worth mentioning that the July uptick appeared more pronounced before rounding.

In tandem with this, consumer spending experienced an acceleration, potentially exerting further upward pressure on prices.

Understanding Core PCE Inflation:

An essential metric, the core Personal Consumption Expenditures (PCE) price index, which excludes volatile food and energy items, also reflected a 0.2% increase, mirroring June’s numbers. This marginal rise pushed the annual increment in these core prices to 4.2%, up from 4.1% the previous month.

This report, in essence, portrays a slightly more substantial monthly surge in inflation when compared to the Consumer Price Index (CPI) data released earlier this month. Both reports indicate a decrease in the prices of goods, such as used cars, as the pandemic-induced supply chain issues have been gradually resolved. However, services, including healthcare, financial advisory, transportation, and insurance, witnessed more significant advances in Thursday’s report. This is partly due to the fact that these services carry a more significant weighting in the PCE than the CPI index. Additionally, higher wholesale costs played a more substantial role, as highlighted in a research note by Barclays.

Exploring Supercore Inflation:

Federal Reserve Chair Jerome Powell has expressed particular concern about persistent inflation within these services, known as “supercore” services. They exclude the volatile categories of food, energy, and housing, with their costs closely tied to rapidly rising employee wages. In July, prices for these “supercore” services surged by 0.5%, following an upwardly revised 0.3% increase the previous month. This uptick might enhance the likelihood of another rate hike, as the Federal Reserve traditionally places greater emphasis on PCE inflation compared to CPI inflation.

Barclays expressed skepticism regarding the possibility of inflation returning to the Fed’s 2% target without a significant improvement in labor market conditions. The firm predicts another quarter-point rate increase in November. On the other hand, Nationwide economist Ben Ayers believes the Fed might raise rates again in September.

The Current Fed Interest Rate:

The current interest rate set by the Federal Reserve stands at a range between 5.25% to 5.5%, marking the highest level in 22 years after experiencing an aggressive series of rate hikes, totaling 5.25 percentage points within a span of 16 months – the most rapid succession of rate increases in four decades.

Household spending, however, saw a robust increase of 0.8% in July, partly fueled by Amazon Prime Day sales, following an upwardly revised 0.6% rise in June. Incomes rose by 0.2%, which was slightly lower than expectations. While incomes have generally outpaced inflation in recent months, this trend seemed to stall in July, potentially reducing consumers’ purchasing power.

Nevertheless, the significant surge in spending could contribute to higher prices and, when combined with a resilient economy, could influence the Federal Reserve’s decision to raise interest rates once more this year. However, consumption may slow down in the coming months as Americans resume student loan repayments, which were temporarily suspended under COVID relief legislation. Additionally, households are drawing closer to depleting their $2.6 trillion in federal stimulus checks and other pandemic-related savings.

What Politicians and Economists Are Predicting:

Pantheon Macroeconomics predicts that the Federal Reserve will maintain its key rate throughout the remainder of the year, following a series of rate hikes that constitute the most aggressive wave of rate increases in four decades. The current rate range of 5.25% to 5.5% represents the highest level in 22 years.

While economic analysts offer differing perspectives, it remains to be seen how the Federal Reserve will navigate these inflationary pressures in the coming months, and whether additional interest rate adjustments will be deemed necessary to maintain economic stability. A key report on U.S. job additions, scheduled for release on Friday, may provide further insights into the Federal Reserve’s potential course of action.