The Fed’s preferred measure of inflation shows signs of cooling

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 as they aim to control rising prices and curb demand.

In May, the personal consumption expenditure (PCE) index rose 2.6% from a year earlier, meeting economists’ expectations and down slightly from April’s 2.7% increase. Excluding more volatile food and fuel prices, core inflation also rose 2.6% year-on-year, down from 2.8% in April. On a monthly basis, inflation remained particularly subdued, with overall prices showing no significant increases.

The Federal Reserve is likely to scrutinize this new inflation data as it considers its next policy moves. Since 2022, the Fed has aggressively raised interest rates to suppress consumer and business demand, which may help slow price increases. However, since July 2023, borrowing costs have remained stable at 5.3% as inflation has gradually eased. The Fed is now deliberating the timing of potential interest rate cuts.

While officials initially planned to implement several rate cuts in 2024, those plans were delayed due to persistent inflation at the start of the year. Policymakers still expect one or two rate cuts before the end of the year, with investors speculating that the first cut could come in September. However, this decision will depend on upcoming economic data, including inflation and labor market metrics.

While inflation remains above the Fed’s 2% annual target, it has slowed significantly from its peak in 2022, when overall PCE inflation reached 7.1%. The consumer price index (CPI), a related measure, peaked even higher at 9.1% and has declined substantially since then.

Fed officials have indicated that rate cuts will begin once they have confidence that inflation is under control or if the job market weakens unexpectedly. While policymakers generally expect inflation to slow in the coming months, some express concern about potential stagnation.

“Much of last year’s progress on inflation was due to supply-side improvements, including easing supply chain constraints, greater availability of workers partly due to immigration, and lower commodity prices. ‘energy,’ said Michelle Bowman, governor of the Fed, 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 risen only slightly,” Mary C. Daly, president of the Federal Reserve Bank of San Francisco, noted 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 moderate in May, further evidence that the economy is losing momentum.