Fed’s preferred inflation measure cools, welcome news

The Federal Reserve’s preferred measure of inflation continued to cool as consumer spending grew only modestly, good news for central bankers who have been trying to suppress demand and rein in price increases.

The personal consumption expenditures index rose 2.6 percent in May from a year earlier, in line with economists’ forecasts but down from 2.7 percent earlier.

After stripping out volatile food and fuel prices to get a better sense of inflation trends, a “core” price measure was also up 2.6 percent from a year ago, down from 2.8 percent in the April reading. And on a monthly basis, inflation was particularly mild, with prices not rising overall.

The Fed will likely keep a close eye on the new inflation data as central bankers consider their next policy steps. Officials have sharply raised interest rates starting in 2022 to curb consumer and business demand, which in turn could help slow price increases. But they have kept borrowing costs steady at 5.3 percent since July 2023 as inflation has slowly fallen, and they are considering when to start cutting interest rates.

Although officials entered 2024 expecting to make several rate cuts this year, they have pushed back those expectations after inflation proved stubborn early in the year. Policymakers have suggested that they still think they can make one or two rate cuts before the end of the year, and investors now think the first cut could lower rates. come in September.

Given Friday’s new inflation data, persistent inflation in early 2024 is “looking more and more like a bump in the road,” Omair Sharif, founder of Inflation Insights, wrote in a post-release note. “Any way you want to slice it, we’ve made significant progress on core inflation over the past year.”

But whether there will be a rate cut in the coming months depends on what happens to economic data – both for prices and for the labor market.

Inflation remains above the Fed’s 2 percent target, but it’s much lower than its peak in 2022, when headline PCE inflation was 7.1 percent. And a separate but related measure, the consumer price index, peaked even higher at 9.1 percent and has also fallen sharply.

Fed officials have made it clear that they will cut rates when inflation has eased enough to be said to be fully under control, or when the labor market unexpectedly cools.

Policymakers generally expect inflation to cool in the coming months, although some have expressed concern that the process may come to a halt.

“Much of the progress on inflation last year was driven by improvements on the supply side, including the easing of supply chain restrictions; increase in the number of available workers, partly due to immigration; and lower energy prices,” Fed Governor Michelle Bowman said said in a speech this week. She suggested that those forces may provide less help in the future.

But other officials are watching nervously as a slowdown begins to grip the broader economy and could soon hit the labor market, fearing that keeping interest rates high for too long could hurt American workers by slowing growth too much.

Hiring has remained strong so far, and while wage growth is cooling, it is still robust. But some measures indicate that working conditions are actually worsening: the number of vacancies has fallen significantly, the unemployment rate has risen slightly and unemployment claims have been increasing recently. checked something.

“The labor market has been slow to adjust, and the unemployment rate has risen only slightly,” Mary C. Daly, president of the Federal Reserve Bank of San Francisco, said in a speech this week. “But we are getting closer to a point where that favorable outcome may be less likely.”

Friday’s report showed consumer spending remained cool in May, further evidence that the economy is gaining steam.

Diane Swonk, chief economist at KPMG, said conditions still look fairly good for now.

“Are we on thin ice yet? Not yet, and it looks like there is room to run,” she said, but noted that the Fed must remain vigilant. “They want to cause a cooling of the economy, not a deep freeze.”