The Federal Reserve’s preferred inflation gauge continues to show signs of cooling, accompanied by moderate growth in consumer spending – good news for central banks aiming to control rising prices and curb demand.
The personal consumption expenditures (PCE) index rose 2.6% year-over-year in May, in line with economists’ expectations and down slightly from a 2.7% gain in April. Excluding the more volatile prices of food and fuel, the “core” inflation measure also rose 2.6% year-over-year, down from 2.8% in April. On a monthly basis, inflation remained remarkably subdued, with overall prices not showing any significant increase.
The Federal Reserve is likely to be looking closely at this new inflation data as it considers its next policy moves. Since 2022, the Fed has been aggressively raising interest rates to suppress consumer and business demand, which can help slow price increases. However, since July 2023, borrowing costs have held steady at 5.3% as inflation has gradually moderated. The Fed is now deliberating on the timing of potential rate cuts.
While officials initially expected to implement several rate cuts in 2024, these plans were delayed due to persistent inflation earlier in the year. Policymakers still expect one or two rate cuts before the end of the year, with investors speculating that the first cut could occur in September. However, this decision will depend on upcoming economic data, including inflation and labor market metrics.
While inflation remains above the Fed’s annual target of 2%, it has slowed significantly from its 2022 peak, when headline PCE inflation hit 7.1%. The related measure, the consumer price index (CPI), peaked even higher at 9.1% and has since fallen substantially.
Fed officials have indicated that rate cuts will begin once they are confident that inflation is under control or if the labor market unexpectedly weakens. While policymakers generally expect inflation to slow in the coming months, some are expressing concerns about potential stagnation.
“Much of the progress on inflation last year was due to supply-side improvements, including easing supply chain constraints, greater availability of workers partly due to immigration, and energy prices lower,” said Michelle Bowman, Fed governor, in a speech this week. She warned that these factors could be less favorable in the future.
By contrast, other officials worry that a broader economic slowdown could soon impact the job market, fearing that keeping interest rates high for too long could excessively curb growth and hurt American workers.
Hiring has remained robust, and while wage growth is cooling, it remains strong. However, some indicators suggest a weakening of working conditions: job vacancies have fallen sharply, the unemployment rate has increased and jobless claims have increased slightly.
“The labor market has been slow to adjust, and the unemployment rate has increased only slightly,” noted Mary C. Daly, President of the Federal Reserve Bank of San Francisco, in a recent speech. “But we are approaching a point where this benign outcome may be less likely.”
The report released Friday found that consumer spending remained subdued in May, further evidence that the economy is losing momentum.
