The Federal Reserve’s preferred measure of inflation continued to cool as consumer spending rose only moderately, good news for central bankers who have been trying to weigh demand and fight rising prices under control.
The Personal Consumption Expenditure Index rose 2.6 percent in May from a year earlier, matching what economists had forecast and down from 2.7 percent previously.
After stripping out volatile food and fuel prices to give a better sense of the inflation trend, a “core” price measure also rose 2.6 percent from a year earlier, up from 2.8 percent in April’s reading. And on a monthly basis, inflation was particularly mild and prices did not rise on an overall basis.
The Fed is likely to watch the new inflation data closely as central bankers ponder their next policy moves. Officials raised interest rates sharply starting in 2022 to hit the brakes on consumer and business demand, which in turn could help slow price growth. But they have held borrowing costs steady at 5.3 percent since July as inflation has slowly eased and they have pondered when to start cutting interest rates.
While officials entered 2024 expecting to make some rate cuts this year, they have pushed back those expectations after inflation proved stubborn earlier in the year. Policymakers have suggested they still think they could make one or two rate cuts before the end of the year, and investors now think the first cut could come in September.
Given Friday’s new inflation data, climbing inflation in early 2024 looks “increasingly like a bump in the road,” wrote Omair Sharif, founder of Inflation Insights, in a post-release note. “However you want to slice it, we’ve made significant progress on core inflation over the past year.”
But whether a rate cut will happen in the coming months depends on what happens with economic data – both on prices and the labor market.
Inflation remains above the Fed’s 2 percent target, but is much slower than it was at its peak in 2022, when headline PCE inflation reached 7.1 percent. And a separate but related measure, the Consumer Price Index, hit an even higher peak of 9.1 percent and has now fallen sharply as well.
Fed officials have been clear that they will cut rates when inflation has slowed enough to make them confident it is fully under control, or if the labor market shows an unexpected cooling.
Policymakers generally expect inflation to cool in the coming months, although some have expressed concern that the process could stall.
“Most of the progress in inflation last year was due to supply-side improvements, including the easing of supply chain constraints; the increase in the number of available workers, partly due to immigration; and lower energy prices,” Michelle Bowman, a Fed governor, said in a speech this week. She suggested those forces may provide less help in the future.
But other officials are nervously watching a slowdown that has begun to grip the broader economy and could soon hit the labor market, worried that keeping interest rates too high for too long could lead to a cost to American workers by greatly slowing growth.
Hiring has remained strong so far, and while wage growth is cooling, it is still strong. But some measures suggest that working conditions are actually weakening – job openings are down sharply, the unemployment rate is up slightly, and jobless claims have picked up somewhat recently.
“The labor market has been slow to adjust and the unemployment rate has only risen,” Mary C. Daly, president of the Federal Reserve Bank of San Francisco, said in a speech this week. “But we are approaching a point where that benign outcome may be less likely.”
Friday’s report showed that consumer spending remained cool in May, further evidence that steam is running out of the economy.
Diane Swonk, chief economist at KPMG, said that for now, conditions still looked quite strong.
“Are we still on thin ice? Not yet, and it looks like there’s room to run,” she said, but she noted that the Fed needs to remain vigilant. “They want to cause a cooling of the economy, not a deep freeze.”